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Are Housing Stocks Overpriced?

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We have gotten used to a spate of positive housing-related news lately. The recovery of this sector is expected to gradually contribute meaningfully to gross domestic product (GDP) and possibly offset weakness arising from a tight federal fiscal policy.

Among the positive developments, sales of new single-family houses increased sequentially by about 16% to an annual rate (seasonally adjusted) of 437,000 units in Jan 2013. This has been the best performance since mid 2008.

Then, the country’s inventory of pre-existing homes (not adjusted seasonally) dropped 4.9% from December to about 1.74 million units in January, which was the lowest supply of homes in many years. At the current level of sales, supplies would be depleted in about 4 months.

Furthermore, the median price for a house resale is on the upswing and the S&P/Case-Shiller Home Price Indices are buoyant. While demand was subdued till recently, there are, at present, not enough homes for sale to meet growing demand. New residential construction in the form of building permits and housing starts were strong in February and fresh residential-related construction is expected to move up sharply in 2013.

Investors are increasingly gravitating toward the U.S. housing market. Even hedge funds have gone long on the sector, a big change from their shorting of sub-prime mortgages during The Great Recession. The most common investment remains residential mortgage-backed instruments followed by long positions on housing stocks. Depending on their risk appetite, investors may invest in low-risk agency-backed mortgages or select riskier instruments not guaranteed by the federal government but offering higher return. Then, investors such as The Blackstone Group LP (BX - Free Report) and others are buying up select properties across the nation to rent them out for a tidy yield.

Incidentally, with home prices on the upswing, home equity lending is back in vogue after many years of decline. Home equity lending is expected to increase, despite greater fiscal discipline than in the past on the part of borrowers, which should provide a fillip to consumer spending in the economy.

The feel good factor led to recent IPO-related activity in the housing sector. TRI Pointe Homes, Inc. (TPH - Free Report) successfully raised funds from the public. It is the first homebuilder to do so in a while.

We look at the highlights of recent performance of some bellwether housing and allied stocks.

PulteGroup, Inc. (PHM - Free Report) , the biggest homebuilder in America, enjoyed strong revenues and earnings in 2012. Its fourth quarter 2012 earnings of 34 cents per share beat the Zacks Consensus Estimate by 9.7% and were significantly better than the prior-year quarter results. PulteGroup’s stock rose almost three fold in 2012 and it was one of the top performers in the benchmark S&P 500. The stock was recently trading at a forward P/E multiple of 18.2x compared with an eye-catching 49.4x for the industry and 14.4x for the S&P 500. We currently have a Zacks Rank #3 (Hold) on PulteGroup.

KB Home’s (KBH - Free Report) adjusted net loss per share of 3 cents in the fiscal fourth quarter (ending November) missed the Zacks Consensus Estimate by 50%. Earnings, however, improved significantly from the prior-year quarter loss of 19 cents driven by topline growth of 20%. KB Home was recently trading at a price-to-book (P/B) of 3.9x compared with 2.1x for the industry and 5.6x for the S&P 500. With the housing market recovery gaining momentum, KB Home believes its strategic initiatives will help it achieve profitability in fiscal 2013. We currently have a Zacks Rank #2 (Buy) on KB Home.

Lennar Corp.’s (LEN - Free Report) adjusted earnings of 48 cents in the fourth quarter of fiscal 2012 (ending November) beat the Zacks Consensus Estimate by 6.8% and the prior-year earnings by 200% driven by 42% growth in homebuilding revenue. The stock was recently trading at a forward P/E multiple of 26.8x compared with 48.7x for the industry. We currently have a Zacks Rank #3 (Hold) on Lennar.

Lowe’s Companies (LOW - Free Report) , the world’s second largest home improvement retailer, reported fourth-quarter fiscal (ending January) earnings of 26 cents per share that handily surpassed the Zacks Consensus Estimate of 23 cents reflecting improved merchandise and higher demand. The stock was recently trading at a forward P/E of 18.3x compared with 24.9x for the industry. We currently have a Zacks Rank #3 (Hold) on Lowe’s Companies.

To sum up, following the run-up in stock prices in housing and allied sectors, we are largely Neutral. However, this evolving housing space may need to be carefully watched for investment opportunities.

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