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KB Home or Meritage Homes: Which is a Better Investment Pick?

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Despite global economic slowdown and rising land and labor costs, the U.S. housing industry is expected to perform well on the back of the Federal Reserve’s dovish stance and declining mortgage rates. Rising wages and lower unemployment level are also adding to the bliss.

The latest sales data of new and existing homes signaled the positives surrounding the industry. Both the metrics were up year over year in the month of July. Notable homebuilders like KB Home (KBH - Free Report) , Meritage Homes Corporation (MTH - Free Report) , PulteGroup, Inc. (PHM - Free Report) and Toll Brothers, Inc. (TOL - Free Report) remain positive, as these have been experiencing steady demand for single-family homes.

Two homebuilders, namely KB Home and Meritage Homes, are the most recognized among the industry bellwethers. Notably, both the companies are almost neck to neck in terms of market cap.

Let’s delve deeper into both the company’s growth and profitability measures.

How the Companies are Poised

KB Home — with a market cap of $2.48 billion — offers a diverse range of new homes that are designed primarily for first time, move-up and active adult homebuyers on acquired or developed lands. It also builds attached and detached single-family and town homes, as well as condominiums.

The company has been benefiting from Built-to-Order approach and Returns-Focused Growth Plan. With these initiatives, it emphasizes on core business strategy, improving asset efficiency and monetizing significant deferred tax assets that further help it gain a competitive edge over its peers and reduce costs. Not only its customer-centric approach is encouraging, but also aggressive investment in land acquisition and development is poised to drive growth. It has invested more than $6 billion in land acquisition and development since 2015, and plans to invest more going forward.

On the contrary, Meritage Homes — having a market cap of $2.49 billion — engages in building and selling single-family homes for entry-level, first-time and move-up buyers in historically high-growth regions of the United States. The company’s successful execution of strategic initiatives to boost profitability and focus on entry-level LiVE.NOW homes — which address the need for lower-priced homes — is expected to yield higher absorptions, aided by an improving community count growth trajectory in 2019.

The leading designer and builder of single-family homes provides financing and related services to customers through the financial services segment.

Stock Performance

KB Home has gained 45.8% so far this year and Meritage Homes’ shares have increased 74.6% compared with industry's 34.3% rally. Both the stocks have also outperformed the S&P 500 composite in the same period.

Hence, when compared with the industry’s collective performance, Meritage Homes has fared better than KB Home.



Earnings Growth Prospects & Surprise History

Analysts expect KB Home’s earnings to grow at a 8.8% rate over the next three-five years. Comparatively, Meritage Homes’ earnings are expected to grow 8.2% over the same time frame. Hence, KB Home’s higher growth rate implies greater potential for capital appreciation.

Earnings of KB Home are expected to grow 56.7% y/y while that of Meritage Homes is likely to decline 4.7% in the current year.

Meanwhile, considering a more comprehensive earnings history, KB Home delivered a positive surprise in each of the last four quarters, while Meritage Homes came up with positive surprises in three of the trailing four quarters. KB Home’s average earnings surprise of 15.1% is better than Meritage Homes’ 13.5%. Hence, KB Home is a clear winner in terms of earnings growth expectation as well as surprise history.

Investors’ Return & Profitability Measures

Profitability and returns are determinants of how well a company has strategized its business and capitalized on opportunities. Return on Capital (ROC) of KB Home is 10%, while that of Meritage Homes and the homebuilding industry is 6.7% and 8.9%, respectively. This signifies that KB Home’s business generates a higher return on investment than Meritage Homes.

Return on Equity (ROE) in the trailing 12 months for KB Home and Meritage Homes is 12.4% and 11.8%, respectively. Markedly, both the companies provide lower returns to its investors compared with the industry’s 14%.

A Look at the Stocks’ Valuation

Let’s take a glance at both the stocks’ P/E, P/B and P/S ratios compared with the homebuilding industry. Notably, these metrics are used for valuing companies and finding out whether these are overvalued or undervalued compared to their peers.

The trailing 12-month price-to-earnings (P/E) multiple for KB Home and Meritage Homes is 10.51 and 12.33, respectively, compared with 9.97 of its industry. KB Homes’ shares are cheaper than Meritage Homes.

Trailing 12-month price-to-book (P/B) multiple for KB Home is 1.12 compared with 1.37 for Meritage Homes. The industry’s P/B is 1.28x. This signifies that KB Home is undervalued compared with Meritage Homes and the industry.

Trailing 12-month price-to-sales (P/S) for KB Home and Meritage Homes is 0.58 and 0.72, respectively, compared with the industry’s 0.82.

After having a look at these valuation metrics, we can say that KB Home is the cheaper of the two stocks.

Our Take

With the help of the above-mentioned factors, we can come to the conclusion that KB Home certainly has an edge over Meritage Homes in terms of earnings growth, stock performance and valuation. Notably, both the stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Going forward, both the companies remain optimistic about the overall homebuilding growth trend, given solid demand for homes, favorable job market and strength in economic fundamentals, offsetting industry woes.

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