Homeownership is a fundamental aspiration which remains a lifelong goal for many. Thus, homebuilder stocks offer promising opportunities for investors and home buyers alike.
Indeed, amid this year’s market turmoil, homebuilder stocks have stayed strong, despite predicted market troubles. Even still, lagging indicators may now be reflecting reality. The bullwhip effect, triggered by consumer demand changes, is impacting the homebuilding market with supply chain challenges.
Therefore, for those concerned about the potential for an upcoming recession, these three homebuilder stocks are ones I’d put in the risky bucket. Just because certain stocks in certain pockets of the market look cheap, it doesn’t mean they are. That’s the definition of a value trap, and I think these three homebuilder stocks could fit into that category right now.
KB Home (KBH)
Amid the 2021 market frenzy, KB Home (NYSE:KBH) was a favored pick. However, with rising interest rates, the notion of addressing housing shortages by building more homes has shifted.
KB Home posted disappointing Q2 2023 financial results. Earnings dropped from $210.7M to $164.4M year over year (YOY), while revenues rose only 3% to $1.77B. Indeed, CEO Jeffrey Mezger noted the company’s book value per share increased 24% to $46.72. Yet, these numbers certainly didn’t knock the socks off many investors who were betting on growth, given the supposed strength of the housing market at this point in the cycle.
It’s also worth noting that KB Home faced challenges during the Great Recession. Despite recent volatility, its year-to-date (YTD) performance is down 27%. However, with a potential global recession ahead, rising interest rates and layoffs could make KBH a stock to sell right now for investors concerned about downside risk.
Toll Brothers (TOL)
Toll Brothers (NYSE:TOL) appears fairly valued now with limited upside. But its stock’s high beta suggests exaggerated price moves could also lead to outperformance in good times and underperformance in bad times. It’s the potential for exaggerated underperformance that should have real estate skeptics worried.
Notably, rising interest rates have affected Toll Brothers, known for its luxury homes priced over $1 million. Potential buyers are holding back, including those upgrading from cheaper homes.
Most of these stocks trade with single-digit price-earnings ratios, and even some at low-single digits, implying expected lower future earnings. A potential bargain or two may arise, as the market might overestimate the downturn for homebuilders. However, Toll Brothers might not fit this pattern.
Lennar (LEN)
Lennar (NYSE:LEN) is a major home construction company facing challenges despite prior successes. Currently, it stands appealing with a strong balance sheet, boasting a cash-to-debt ratio ranking above 63.55% of peers. Its Altman Z-Score of 4.73 signals fiscal stability and low bankruptcy risk.
Despite offering incentives and trimming prices, caution is needed due to changing real estate dynamics. The company’s positive stats are based on outdated paradigms, warranting a reevaluation of exposure.
Lennar exceeded Q2 profit and sales expectations by constructing 1,000 more homes than anticipated, benefiting from a tight housing market and higher mortgage rates. However, Q2 EPS fell 33% to $3.01, sales dipped 4% to $8 billion, indicating a slowdown. I think more underwhelming numbers are likely on the horizon, which makes it a stock on my sell list right now.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
