Housing Market Improves: 3 Stock Choices - Analyst Blog

The U.S. Census Bureau and the Department of Housing and Urban Development reported upbeat data on new single-family home sales yesterday. Sales of new single-family houses increased 18.6% from April's revised rate of 425,000 to a seasonally adjusted annual rate of 504,000 in May. New home sales for the month of May increased to the highest level in six years.

Home Sales Surge

The rise was also larger than expected as the consensus estimate predicted it would improve to 439,000. This data comes close on the heels of encouraging existing home sales data released on Monday. Existing home sales rose 4.9% to a seasonally adjusted annual rate of 4.89 million in May from an upwardly-revised 4.66 million in April.

Existing home sales increased at the fastest pace in seven months. A strong labor market, expansion in inventories and drop in mortgage rates were cited to be the reason behind strong growth in this metric.

Distressed Sales Decline

However, it is important to note that new home sales show great variance month over month. Again, a closer look at existing home sales data reveals that sales recorded in May are lower than the year-ago figure of 5.15 million.

But a more optimistic picture emerges when we look at distressed sales numbers. Foreclosures and short sales make up 11% of the sales in May. According to the National Association of Realtors, distressed sales have declined by seven percentage points over the past year. Existing home sales have increased 3% compared to May 2013 when we exclude distressed sales.

Prices Increase Falls

The S&P/Case-Shiller Home Price Indices report revealed that increase in home prices was slowing. The 10 and 20-city composite indexes moved up 1% and 1.1% respectively during April. However, annual increases have declined.

The 20-City composite index rose 10.8% year on year in April. However, the rate of growth was lower than March's year-on-year rise of 12.4%. It was even lower compared to the 13.7% increase recorded in November last year.

A Sustainable Recovery

According to the chief economist of real estate site Trulia, just 3% of national home prices are undervalued when considering long-term fundamental factors. Some markets, such as South California are highly overvalued.

The Case-Shiller report is drawn from transactions concluded during the period between February and April. This makes it a good indicator of activity for the early part of the year. A decline in price increases implies that the housing market may be stabilizing.

The ideal situation for home prices is where the interests of both housing companies and homeowners are satisfied. Price increases do not race ahead of wage increases and homebuilders make enough profits to undertake new construction. Bubbles do not build up and sudden corrections can be avoided. Based on Case Shiller pricing data we could conclude that such an equilibrium may be on its way.

Our Choices

Established stocks with proven track records would be ideal stocks in the current scenario. Below we present three housing stocks which possess the potential to grow appreciably, each of which also has a good Zacks rank.

DR Horton Inc. DHI is one of the leading national homebuilders, primarily engaged in the construction and sale of single-family houses both in the entry-level and move-up markets. In fiscal 2013, the company closed 24,155 homes at an average sales price of $249,400.

The company's second-quarter fiscal 2014 results surpassed the Zacks Consensus Estimate for both revenues and earnings. Adjusted earnings of $0.38 per share in the second quarter of fiscal 2014 beat the Zacks Consensus Estimate of $0.34 by 11.8%. Earnings grew 18.8% year over year driven by improved homebuilding revenues and strong margin expansion.

DR Horton Inc. holds a Zacks Rank #3(Hold) and has expected earnings growth of 31.4%. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 13.67.

Lennar Corp. LEN is engaged in homebuilding and financial services in the U.S. It is considered to be one of the leading homebuilders within the industry. Despite a diversified product portfolio, homebuilding remains its core business.

Lennar's first-quarter fiscal 2014 adjusted earnings of $0.35 per share beat the Zacks Consensus Estimate of $0.28 by 25.0%. Earnings jumped 34.6% year over year driven by double-digit growth in homebuilding revenues and solid margins.

Currently the company holds a Zacks Rank #3 (Hold) and has expected earnings growth of 28%. It has a P/E (F1) of 16.28.

Toll Brothers Inc. TOL builds luxury single-family detached and attached home communities. It also constructs master planned luxury residential resort-style golf communities principally on the land it develops and improves. The company also caters to buyers above 50 years of age, active adult buyers, second homebuyers and move up home buyers.

Toll Brothers reported adjusted earnings of $0.31 per share in the second quarter of fiscal 2014, surpassing the Zacks Consensus Estimate of $0.25 by 24%. Adjusted earnings increased significantly from $0.07 in the prior-year quarter on the back of strong revenues and margins.

Apart from a Zacks Rank #3 (Hold), Toll Brothers has expected earnings growth of 74.8%. It has a P/E (F1) of 20.92.

It may take some time before we can reach an unambiguous opinion on the housing sector. But recent data suggests that a recovery is on track. This is why these stocks would make good additions to your portfolio.