Are Home Builder Stocks A Value Trap?

Luna Ruth

Our theme of Housing Stocks, which includes the stocks of home builders, building products companies, and home improvement players, has declined by about 32% year-to-date, compared to the S&P 500, which remains down by about 8% over the same period. The sharp sell-off in the housing space comes amid a surge in mortgage rates, with the 30-year fixed-rate mortgage in the U.S. rising to an average of 5% last week, up from levels of roughly 2.7% seen in January 2021. Moreover, inflation in the U.S. has also surged to 40-year highs, rising by 8.5% from a year ago in March, and this is also putting pressure on home builders and buyers.

While things have remained quite strong on the demand side as the U.S. continues to see a strong labor market with rising wages, the housing market could be poised to cool off. While housing starts, which are an indicator of new home building, rose by about 6.8% to a seasonally adjusted annual rate of 1.769 million units in February, beating estimates, expectations are that they will fall in March. The data is due to be published on Tuesday. The median sales price of new homes has also declined a bit, falling to $400,600 for February, down from $423,300 in January although it remained up by 10.6% on a year-over-year basis. Now mortgage rates could be set to rise further, as the Fed considers more aggressive rate hikes to fight inflation. This could make it more expensive for homebuyers to finance their purchases, crimping housing demand and pricing to an extent.

The valuations of some of the top homebuilder stocks are also telling. For example, D.R. Horton and Lennar

trade at just over 4.5x consensus 2022 earnings, despite consensus revenue growth rates for this year standing at a healthy 20% or more for both companies. This compares to the S&P 500, which trades at about 19x forward earnings. Cyclical stocks often tend to have low multiples when investors expect that the industry is peaking, and this is probably what is happening with housing names, as well, at present.

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