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Home Builders May Be on the Rebound

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Dear Mr. Berko: I think the home building stocks will come back a lot sooner than expected. In fact, I think that home building stock prices have hit bottom. My broker tells me that his firm is neutral on the industry and can't recommend any stock to me unless it's on his firm's "buy" list.

I took some good profits in late 2006, when you put the kibosh on home building stocks, and now I want to buy them back again. I have $45,000 to invest and would like you to give me the names of three home builders that you feel have the best long term chance of recovery. I would invest $15,000 in each. And do you agree that the home building stocks will come back?

Thank you in advance for your help. — CP, Jonesboro, Ark.

Dear CP: Of course home building stocks will come back. And they'll come back precisely when you least expect them to come back.

Your broker's research department employs two of the most brilliant analysts in the housing industry; their knowledge is so exhaustive that it's said they can predict, to the nearest 10,000, the precise number of 16 penny nails that will be manufactured in any given year.

These guys are good, and I respect their opinions. And while they rank the home building industry as neutral, you must ask your broker, "Where on the scale of neutral do these lads rank the industry?" This is important. For instance, are they strongly neutral (which is nearly a "sell")? Moderately neutral (which is neither a "buy" nor a "sell")? Or are they lightly neutral (which is nearly a "buy")?

Many brokerages began to recommend housing stocks in late 2005 and early 2006, when the S&P Home Builder's Index (XHB-$19.97) was trading about $35 on its way to $46. But brokerages continued to recommend home builders until the XHB had fallen from $46 to the mid-$20s. So if you can determine where on the neutral-scale these guys rank, it might help you define a good entry point. I suspect, however, that the brokerage industry will begin to recommend the home builders when XHB begins trading on the low $30s.

The biggest and the best might be PulteGroup (PHM-$7.99), which traded as low as $3 a share in 2011 and as high as $48 in 2005.

PHM builds single-family homes, develops subdivisions in 29 states and should generate $4.3 billion in revenues this year that may produce $75 million in net income, or 20 cents a share. PHM has a $5.22 book value and $2.94 in cash per share. In the coming few years, PHM could trade in the mid-$20s.

D.R. Horton (DHI-$14.30) builds single-family homes in 73 markets located in 25 states. This company, with a potential of $4.2 billion in revenue (up from $3.5 billion in 2011), expects to produce a profit of $165 million this year on a swell 2.9 percent net profit margin. DHI has a lean cost structure, a four- to five-year supply of land, a book value of $8.39, and $4 cash per share. The shares traded in the low $40s in 2006 and hit a low of $4 a share in 2008, but in the coming few years, the shares could trade in the high $20s.

Finally, the Ryland Group (RYL-$18.70), a $1.1 billion revenue builder, specializes in on-site construction of single-family detached and attached homes and provides mortgage services. RYL is a low priced builder that sells homes between $100,000 and $450,000, and it expects to earn $18 million this year and will pay a 12-cent dividend. RYL has an $11.31 book value and a huge cash position of more than $11 per share. In 2006, RYL traded in the low $80s and last year traded as low as $9.25. In the coming few years, RYL could trade in the high $30s.

Now, if the brokerage industry is true to form, it will recommend the purchase of Pulte when Pulte trades between $15 to $17; D.R. Horton when its shares trade in the high teens; and Ryland Group when its shares trade in the mid-$20s. I think your timing may be good because the industry won't recommend these issues until their share prices have doubled from their current market values. You may have to wait a couple of years before your money doubles or triples, but that's a reasonable time frame.

There are lower-quality home builders not as strongly positioned as LEN, DHI and RYL, and they have appealing but speculative appreciation potential. So spread the risk a bit and consider buying a thousand shares of Beazer Homes (BZH-$3.21), Standard Pacific (SPF-$3.97) and Hovnanian Enterprises (HOV-$2.64). They may surprise you by 2015.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at mjberko@yahoo.com. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

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