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Score Potential Double-Digit Returns With This Homebuilder by Year-End

Melvin Pasternak

The U.S. housing recovery continues to gain momentum. There are several ways for you as an investor to take advantage of this trend. You could buy a second home in one of the recovering but still depressed markets such as Atlanta. Or you can scoop up a homebuilding ETF. As a group, the homebuilders are markedly off their lows, but still well below their all-time highs set in 2006 or 2007. My preference, though, is to buy select shares.

According to the National Association of Realtors, U.S. housing prices rose 11.8% in March, the largest year-over-year gain since November 2005. The increase was caused by low inventory. Since fewer homes are available, buyers are willing to pay $184,300 for a typical home, compared to $164,800 last year.

New home construction is also on the rise in the United States. Housing starts increased 7% in March from February, and almost 47% over March 2012. This jump shows strong builder confidence in the improving market.

Historically low mortgage rates, coupled with increasing home values, are two factors bringing eager buyers back into the housing market. This is great news for The Ryland Group (RYL).

One of the largest homebuilders in the United States, Ryland is also a leading mortgage financer. Since 1967, the California-based company has built over 300,000 homes and has financed nearly as many mortgages. Ryland's hallmark is its commitment to energy-efficient homes. The company aims to build in Energy Star certified communities, and this eco-friendly approach helps set it apart from its competitors.

Capitalizing on the increased demand for new homes, Ryland recently reported upbeat first-quarter 2013 results. Revenue soared to $374.7 million, up 73.6% from the year-earlier quarter. Over this period, orders for new Ryland homes increased 54% to 2,051 units compared to 1,328 in Q1 2012.

The homebuilder sold more homes and at higher prices. As a result, first-quarter earnings turned positive, coming in at $0.43 per share compared to a loss of $0.07 in the comparable year-ago period. Management reported the average customer paid $277,000 for a Ryland home, an 8.2% increase from a year earlier.

During the quarter, the company completed sales of 1,307 homes, a 60% increase from the 815 completed home sales in the year-earlier quarter. Ryland ended the 2013 period with a backlog of 3,135 homes under contract, a 57% increase from the prior-year quarter. Since current backlog is a strong indicator of potential future revenue, the near-term financial outlook for Ryland looks good. The start of the spring buying season -- typically the busiest home-buying period of the year -- should further spur near-term growth.

From a technical perspective, the chart is strong.

RYL Stock Chart

Climbing from an October 2011 multi-year low near $9, shares have formed a major uptrend, gaining an incredible 440% to date, hitting a new 52-week high this week near $49. This level has not been seen since the mid-2000s. In July 2005, the stock peaked at an all-time high above $82. 

Between the fall of 2011 and 2012, RYL made major gains rising to a peak near $34 in September 2012, before trading sideways until December. Breaking out beyond resistance near $36, the shares hit a high near $43 in late January 2013, before retreating to support near $33.50 in February. In March, shares again crept up to the $42 range, backed off this resistance level once more, and slid back to the mid-$30s in early April.

In late April, on upbeat first-quarter results, the stock surged above resistance at $42, climbing on above-average volume. Shares have edged higher since.

The $42 level now acts as a shelf of support. With no nearby historical resistance in sight, the stock could move higher, eventually challenging its July 2005 $82 peak. The next significant resistance is near $60. This was a major support level in 2006 as the stock was topping, and an early 2007 countertrend rally peak.

The bullish technical outlook is supported by stellar fundamentals. Because of strengthening demand for new homes, analysts project second-quarter revenue, scheduled to be reported on July 22, will surge 62% to $476.1 million compared to $293.8 million in the comparable year-earlier quarter.

For the full 2013 year, analysts expect increased selling prices will push the homebuilder's revenue up 56% to $2 billion from $1.3 billion last year.

The earnings outlook is also bright. Analysts estimate Ryland's second-quarter earnings will more than quadruple, reaching $0.58 per share from $0.14 in the year-earlier period. For the full 2013 year, analysts expect increased demand and higher profit margins will cause earnings to soar more than 205% to $2.57 per share compared to $0.84 last year.

Despite the gains in share price, the company is still a good value with a five-year PEG ratio (price-to-earnings ratio divided by earnings per share growth rate) of just 0.33. Typically, a PEG of 1 or under shows good value. 

The company also pays a small annual dividend of $0.12 per share for a 0.3% yield. Based on improving earnings, this amount could rise.

Risks to consider: A drastic downturn in the economy could reverse the housing rebound. However, with mortgage rates near all-time lows, Ryland, as a mortgage provider and a homebuilder, should continue to see growth.

Recommended Trade Setup:

-- Buy RYL at the market price
-- Set stop-loss at $42.79, slightly below the current shelf of support
-- Set price target at $59.85 for a potential 22% gain by year's end

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