Why Did Homebuilding Stocks Surge?

Posted by: Ben Steverman on August 11, 2009

When you buy stock in a corporation, you theoretically are buying rights to a slice of that company’s future profits. So how do you value a stock when those profits are almost nonexistent, both now and for the foreseeable future?

That’s arguably the situation for homebuilders. Yes, the housing market may be stabilizing. But a true recovery for this sector is almost certainly a few years, maybe several years, in the future.

So how to explain what’s happened in the last month? Homebuilding stocks have surged.

Consider, from July 8th to Aug. 7th:
Toll Brothers (TOL), up 40%
D.R. Horton (DHI), up 61%
Pulte Homes (PHM), up 21%
Lennar Corp. (LEN), up 63%
KB Home (KBH), up 62%
Centex Corp. (CTX), up 60%
Ryland Group (RYL), up 56%
Hovnanian Enterprises (HOV), up 144%
Beazer Homes USA (BZH), up 163%
Brookfield Homes Corp. (BHS), up 121%

Most of these stocks backed off on Aug. 11, after the release of a Stifel Nicolaus (SF) report by analyst Michael Widner — titled “Is the Homebuilder Rally for Real?”

His answer: Probably not. Widner notes, “The companies with the worst balance sheets performed the best.” He tries to explain:

We believe the weakest balance sheets tend to outperform in this environment because investors expect that 1) the rising economic tide will lift all boats, and 2) cheap boats will offer the highest bang for the buck so to speak.
Some of homebuilder stocks’ rally could be explained by the stabilization of certain economic measures. But, the data haven’t changed that quickly. Nor is a better economy or a stabler housing market likely to translate into significantly better homebuilder earnings for quite some time.

Also, another “fundamental” measure of these stocks — recent earnings reports — had no perceptible effect on homebuilders’ share performance, Widner argues.

With the outlook for homebuilders remaining very murky, and a full recovery and predictable earnings “a few years away,” these stocks are trading on that elusive concept of “sentiment.”

We believe sentiment drives the sector, not fundamental valuations and we see future data as unlikely to support the recent rise in sentiment.

A few lucky shareholders have doubled their money by correctly predicting when beaten-down, underappreciated homebuilder stocks would get their due. But those traders must also know that the winds on Wall Street can shift quickly.

When the homebuilding business is this slow, a disappointing housing data point or a skeptical analysts report are all it can take to turn the stock market’s leaders into its laggards.

Reader Comments

Tony

August 13, 2009 11:24 PM

Financial Planner Minnesota

Lets just hope the home stocks keep surging and the values of homes goes up as well.

Tony

August 13, 2009 11:24 PM

Financial Planner Minnesota
Lets just hope the home stocks keep surging and the values of homes goes up as well.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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