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Shrug Off Housing Market Woes With These Top 3 Value Picks

Shrabana Mukherjee
We have shortlisted three stocks from the top-notch Homebuilding industry, which are likely to benefit investors on the back of a solid U.S. economy and higher demand.

Of late, myriad problems have been plaguing the U.S. homebuilding industry, leading to its significant slowdown. The industry has declined 20.7% year to date against a 7.7% rise of the S&P 500 Composite. Even big names like Lennar LEN, D.R. Horton DHI, PulteGroup PHM, KB Home KBH and NVR Inc. NVR have plunged 17.1%, 11.2%, 12.8%, 20.2% and 22.9%, respectively, so far this year.

Factors like increasing construction costs, dearth of skilled labor and rising prices of homes owing to higher mortgage rates continue to make things difficult. Meanwhile, builders are perturbed by higher aluminum and steel costs, thanks to the newly-imposed tariffs. This, coupled with increased lumber prices owing to an import tariff, is denting builders’ margins.

Both new and existing home sales data came in below expectations for the second month in a row, further pointing toward a struggling housing market. Sales of newly-constructed homes in July was the lowest since October 2017. It was 1.7% lower than June sales, but 12.8% higher than the year-ago tally. Existing-home sales fell for the fourth straight month in July to the slowest pace in over two years, according to the National Association of Realtors.

The above-mentioned deterrents shouldn’t lead investors to steer clear of the housing industry altogether. The housing market indicators that remained upbeat are building permits and housing starts. New residential construction data was positive with housing starts rebounding in July after touching nine-month lows in June. Moreover, building permits increased in July after declining for three months consecutively.

Reaffirming Positive Outlook

August readings gauging builders' view on sales over the next six months slipped from July. Nevertheless, homebuilders' overall vision of the new-home market remains positive.

The housing market is expected to gradually recover through the rest of the year, backed by solid ongoing job market, economic growth and rising consumer confidence. New home sales figure was higher than last year, reflecting strong demand for homes as the economy continues to create jobs.

The annualized growth rate was 4.1% in the second quarter of 2018, almost double the 2.2% rate in the first quarter and the strongest figures since third-quarter 2014. The upsurge was mainly attributable to positive contributions from household spending, exports and business investment. The U.S. economy is expected to grow at a 4.6% annualized rate in the third quarter, per the latest Atlanta Federal Reserve’s GDP Now forecast. Meanwhile, unemployment rate in July was 3.9%. Rate of unemployment was only 0.2% short from the lowest level reached in the last 50 years.

The industry ranks among the top 43% (109 out of 265 industries). Despite the somber past performance, a solid rank signals that the industry is likely to benefit from favorable broader factors in the immediate future.

Industry Valuation

Owing to the asset-driven nature of homebuilders, it makes sense to determine their value on the basis of the price-to-book ratio. The Zacks Homebuilding industry is undervalued compared to the broader S&P 500 Composite. The industry currently has a trailing 12-month P/B of 1.3x, less than the market’s current P/B of 4x. Its lower-than-market position hints at an upside in the quarters ahead.

Looking at the more commonly used Price to Earnings Ratio, the industry currently has a forward 12-month P/E of 8.1x, which is equal to the lowest level over the past year. The space also looks equally cheap when compared with the market at large, as the forward 12-month P/E ratio for the S&P 500 is 17.4 and the median level is 17.6.

Thus, it is fair to say that a slightly more value-oriented path may be ahead for the industry in the near term. Therefore, it makes sense to add some value stocks with solid growth potential from the industry to your portfolio right now.

Picking the Right Stocks

Owing to the month-to-month volatile figures, investment in the construction sector at times becomes difficult. Investors need to be cautious while picking value stocks. It is important to note that some of the stocks are deemed to be undervalued with no upside potential. Or, they may appear undervalued as per one metric, but not when judged by another. Our Value Style Score separates the wheat from the chaff by using multiple criteria to truly find the most attractive value stocks.

The Growth Style Score, in the meanwhile, analyzes the prospects of a company and also evaluates its corporate financial statements.

We have shortlisted homebuilding stocks with a Value Score of A or B as well as an impressive Growth Score of A or B. The stocks also have a solid Zacks Rank #1 (Strong Buy) or 2 (Buy). Back-tested results have shown that stocks with a Style Score of A or B coupled with a bullish Zacks Rank are the best investment options. You can see the complete list of today’s Zacks #1 Rank stocks here.

PulteGroup Inc. engages in the homebuilding and financial services businesses primarily in the United States. The stock sports a Zacks Rank #1 and has a favorable Value Score of A and Growth Score of A. The company has solid expected earnings growth of 61.2% for the current year and 10.4% for the next.

D.R. Horton, Inc. 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. The stock sports a Zacks Rank #1 and has a favorable Value Score of B and Growth Score of A. The company has solid expected earnings growth of 41.2% for the current year and 19.6% for the next.

Century Communities Inc. CCS, a home building and construction company, has a Zacks Rank #2 and a Value Score of B. The company has solid expected earnings growth of 27.2% for the current year and 31.1% for the next.

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