Housing stocks are trading at single digit multiples. Why? There is a lot of hate out there!
Many analysts look at small moves, short time periods, and the wrong measures. This provides an opportunity for those of us who focus on longer-term fundamentals. In this second article in our two-part series (see part one here), I’ll start by a closer look at the negative arguments based upon price.
Prices are the wrong measure of this market
Many sources emphasize prices as the most important measure of the strength of this market. That is mistaken. Since home prices reflect the intersection of supply and demand curves, there are many reasons for a change in price. These include lower costs for builders – land, materials, or financing. Any of these would shift the supply curve to a lower intersecting price. While it is convenient to summarize the entire market with a median price, there is a lot of variation by price level and region.
Even if using prices, Case-Shiller is the wrong measure.
This is especially true if the twenty-city version is used. Any of the Case-Shiller methods has older data than other approaches.
As a comparison, the AEI has a price index that combines Case-Shiller with other more current data. Their quite different findings show the importance this approach.
The AEI Housing Center research also shows that the price pressure is concentrated at the high end of the market.
New Home Sales
A better measure is the level of new home sales. These are most important for the economy, and most relevant for the home building stocks. And new home sales have been doing quite well.
I like to find investments where I expect economic, social, political, and demographic trends to be supportive. There are some important factors in the housing sector.
Lower mortgage rates have a big effect on affordability, without cutting the profits of the builders. These charts show the impact on both existing home sales and new home sales.
The biggest tailwind comes from demographics. The major driver of the housing sector is household formation.
Pulling the Threads Together
Whenever you see a “soft” housing report, there is usually a comment about low inventory. Buyers seemingly can’t find what they want, and sellers won’t move without higher prices.
Now pretend that you are an executive at one of the big home-building companies. You can see the demand at the lower end of the market, and lower interest rates have given you better margins. It is within your power to shift emphasis from high-priced (and high profit) homes to those at the entry level. We can already see that happening with some builders.
These factors have provided additional support for home builder confidence. I like investments where the management has control of the company’s fate.
There are many good names in this space, but here are the F.A.S.T. Graph charts for two of them. While you would certainly want to dig deeper than the basic overview, you should note that debt in this business has solid collateral. I own both stocks and explored some of their retirement developments in my recent road trip with Mrs. OldProf.