Attractive valuations in the U.S. homebuilding sector.
Sales of new U.S. homes rose in December to a nine-month high, indicating an increase in demand at the end of 2021 despite high prices and limited inventory. Looking at data from Trading Central’s Economic Insight tool, we noticed actual U.S. monthly new home sales have been reported above economic forecasts for the past six months in a row. Looking at the trend of building permits data, we are at record-high levels – another positive sign for U.S. homebuilders.
Meanwhile, the SPDR S&P Homebuilders ETF (XHB-N) is down 23.2-per-cent year-to-date and up 3.9 per cent over one year, which might be of interest to value investors. Could this be a unique low value situation in a homebuilding sector that’s surging despite higher material, labour and financing costs?
We will be using Trading Central Strategy Builder to search for U.S. homebuilder stocks that are well-valued, along with a combination of strong return on equity and low debt levels. We begin by searching for stocks exclusively in homebuilding and construction, which is a subsector of the broad consumer cyclical sector.
We screened for companies indicating a return on equity of at least 10 per cent to see how effectively management has used invested capital to generate income. The screen will also focus on stocks with a price-to-earnings ratio lower than 21 in order to find companies with better than average valuations compared with the average P/E of the S&P 500, which sits around 21.3. We focused on companies with low levels of debt in anticipation of higher interest rates – specifically, companies indicating a debt-to-equity ratio of one or less. (The higher the ratio, the more leveraged the company is.) Finally we required a minimum market capitalization of US$1-billion.
We have also included annual dividend yield, year-to-date and one-year total return.
Trading Central is a global leader in financial market research and investment analytics for retail online brokers and institutions. Trading Central’s product suite provides actionable trading ideas based on technical and fundamental research covering stocks, exchange-traded funds, indexes, forex, options and commodities.
Topping our list is Lennar Corp., a homebuilder and an originator of residential and commercial mortgage loans. The company is also a developer of multifamily rental properties. Lennar has the lowest debt-to-equity on our list at just 0.31. The company has the second-highest dividend yield on our list at 1.8 per cent.
D.R. Horton Inc. is a major U.S. homebuilder. The company also offers homebuyers mortgage financing and title agency services through its financial services segment. D.R. Horton has the largest market cap on our list at US$27.7-billion. Looking at debt-to-equity, it has the second-lowest on our list at 0.34. The stock has declined 27 per cent from its record high reached in December.
Century Communities Inc. develops and sells single-family attached and detached homes. The company has the highest return on equity on our list at 32.7 per cent. The company also just raised its quarterly dividend by 33 per cent to 20 US cents a share and now yields 1.4 per cent.
Trading Central Strategy Builder provides a back-testing capability to evaluate how well an investing strategy would have worked in the past. Using a five-year historical period with quarterly rebalancing, the screen described had a 17.1-per-cent annualized total return compared with 12.9 per cent for the S&P 500 Total Return Index.
The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Trading Central in respect of the investment in financial instruments. Investors should conduct further research before investing.
Gary Christie is head of North American research at Trading Central in Ottawa.
