Why are residential construction stocks so undervalued?

yellowbastard · #1 01-30-2007, 11:45 PM

Recently, I've been looking at a few stocks in the residential construction industry. Many of the companies look very attractive such as NVR , which reported eps of $98.09 last year against a stock price of only $653 (6.7x earnings). NVR has also grown its earnings at an incredible rate of over 50% compounded annually for the past 10 years. As it turns out, this is not all that uncommon for NVR's competitors,

<u>10 year growth</u>
CTX 29%
PHM 38%
RYL 42%

The avg. P/E for these companies is about 6.58.
Seems almost too good to be true, what am I missing here?

squiffy · #2 01-31-2007, 12:00 AM

A low P/E ratio does not necessarily mean a stock is undervalued. Oftentimes, stocks in certain highly cyclical industries will have very low P/E's because there is a limit to how fast their earnings can be expected to grow, if at all.

A young starbucks or Best Buy may have incredible growth potential. But a GM, Ford or large homebuilder may be pretty limited in how quickly they can grow their profits, if at all.

See Peter Lynch, Beating the Street, at p. 233.

So, do you think this is a good time to buy into the residential construction industry? Why or why not?

Cubswin · #3 01-31-2007, 01:18 AM

Residential construction is stagnate and those growth numbers shouldnt be expected over the next few years... or for quite some time.

yellowbastard · #4 01-31-2007, 01:25 AM

NVR has grown its earnings at a rate of over 50% per year for the past decade. People would have to buy considerably fewer houses in the future to warrant a 6.5 industry average P/E and I just don't think this is the case. People have to have a place to live and I don't think people will buy houses any differently in the next ten years as they did in the past ten years.

Looking at the fundamental data and economic characteristics of the company, it seems like a no brainer to me, but obviously Mr. Market thinks the exact opposite and I am very curious as to why.

This leads me back to my original question: how can these great companies that have grown their earnings so well and manufacture a product that serves a repetitive need (housing) be so incredibly cheap?

yellowbastard · #5 01-31-2007, 01:26 AM

[ QUOTE ]
Residential construction is stagnate and those growth numbers shouldnt be expected over the next few years... or for quite some time.

[/ QUOTE ]

Why?

notluck · #6 01-31-2007, 02:10 AM

Looking at CTX. Notice how they have low cash balances and high inventory. More importantly notice the trend. Lastly, when was the last time they made cash from operations? I am novice, but that is one issue to think about.

P.S. Though leverage of 3:1 isn't so bad but just makes you wonder.....

-Alex

Cubswin · #7 01-31-2007, 02:23 AM

Because we've had a huge run up in real estate over the past 10 or so years. Currently, inventories are high, interest rates have risen, foreclosures are up (Thanks be to ARMs) and many more people are over extended so the foreclosure rate should go higher as well. Many many new homes and condos built at the later end of the boom are sitting vacant with huge incentives being offered. Still, they arnt moving. I think it might be a long term value play but I still believe we are in for more correction.

pig4bill · #8 01-31-2007, 02:32 AM

You're looking in the past. Last year's E does you no good if you plan to sell the stock in the future. Look at the projected E and you'll see.

yellowbastard · #9 01-31-2007, 02:53 AM

[ QUOTE ]
You're looking in the past. Last year's E does you no good if you plan to sell the stock in the future. Look at the projected E and you'll see.

[/ QUOTE ]

Projected growth rate is lower, but still not that bad...

Yahoo: 11%
MSN: 15%
Quicken: 15%

squiffy · #10 01-31-2007, 08:19 AM

There is a big difference between housing consumption and Starbucks or Best Buy consumption.

One person can drink a lot of Starbucks in a year. And you can add quite a few Starbucks nationwide and internationally.

It's hard for American builders to build and sell homes overseas, to export homes, if you will. And it's hard for every American to buy one home a day. I can see one person owning one or two homes. But it's not likely that the average person will buy 10 homes.

So the volume and absolute number of home purchases is limited by income and population growth.

If you think it's cheap, you should buy a lot of it. But I don't think it's cheap. Go to the library and read that passage from Peter Lynch that I cited.

Or review what other stock pickers have to say about investing in cyclical industries.

If people were that enthusiastic about the homebuilding industry, then shouldn't it have a P/E like Google's or Starbuck's???

Perhaps you are just smarter than everyone else out there. It's possible!!!!!