To select positions for the portfolio at his Validea newsletter, John Reese assesses stocks based on the historic criteria used many of the market's most legendary investors; here he reviews three homebuilding stocks, each chosen by a different investment methodology.
Strategy: Growth/Value Investor
Based on: James P. O'Shaughnessy
D.R. Horton, Inc. (DHI) is a homebuilding company. The Company has operations in 84 markets in 29 states across the United States. The first requirement of the Cornerstone Growth Strategy is that the company has a market capitalization of at least $150 million.
More from John Reese: Top Picks 2020: American Express (AXP) and Mastercard (MA)
The Cornerstone Growth methodology looks for companies that show persistent earnings growth without regard to magnitude. To fulfill this requirement, a company's earnings must increase each year for a five year period.
DHI, whose annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were $2.03, $2.36, $2.74, $4.09 and $4.29, passes this test.
The Price/Sales ratio should be below 1.5. This value criterion, coupled with the growth criterion, identify growth stocks that are still cheap to buy. DHI's Price/Sales ratio of 1.23, based on trailing 12 month sales, passes this criterion.
The final criterion for the Cornerstone Growth Strategy requires that the Relative Strength of the company be among the top 50 of the stocks screened using the previous criterion.
This gives you the opportunity to buy the growth stocks you are searching for just as the market is embracing them. DHI, whose relative strength is 91, is in the top 50 and would pass this last criterion.
Strategy: Small-Cap Growth Investor
Based on: Motley Fool
PulteGroup, Inc. (PHM) is a homebuilder in the United States. The Company offers a range of home designs, including single-family detached, townhouses, condominiums and duplexes.
This methodology seeks companies with a minimum trailing 12 month after tax profit margin of 7%. The companies that pass this criterion have strong positions within their respective industries and offer greater shareholder returns.
A true test of the quality of a company is that they can sustain this margin. PHM's profit margin of 9.96% passes this test.
The investor must look at the relative strength of the company in question. Companies whose relative strength is 90 or above (that is, the company outperforms 90% or more of the market for the past year), are considered attractive.
Companies whose price has been rising much quicker than the market tend to keep rising. PulteGroup, with a relative strength of 92, satisfies this test.
The company also meets the requirements for cash flow from operations, profit margin consistency, and inventory to sales. In addition, the company has a large amount of cash — $1.2 billion — on hand.
A company like PulteGroup has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash.
Strategy: P/E/Growth Investor
Based on: Peter Lynch
M.D.C. Holdings, Inc. (MDC) is engaged in two primary operations, including homebuilding and financial services. This methodology would consider MDC a "fast-grower".
The investor should examine the P/E (12.00) relative to the growth rate (31.21%), based on the average of the 3, 4 and 5 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for MDC (0.38) is very favorable.
This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years.
This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for M.D.C. Holdings is 31.2%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is acceptable.