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5 Stocks to Play Strength in Booming Homebuilding Industry

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·9 min read
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Indeed, the U.S. housing space continues to grapple with the rising raw material and labor costs. Also, disruption in the supply chain arising from the novel coronavirus outbreak may impact builders’ ability to deliver on time. That said, the rising need for more work-at-home space has been aiding the Zacks Building Products - Home Builders industry. Also, companies like D.R. Horton, Inc. DHI, Lennar Corporation LEN, Toll Brothers Inc. TOL, PulteGroup, Inc. PHM and KB Home KBH have been gaining from higher demand, focus on cost control, increased operating leverage, and important buyouts.

Industry Description

The Zacks Building Products - Home Builders industry comprises manufacturers of residential and commercial buildings. Some of the industry players are involved in providing financial services that include selling mortgages and collecting fees for title insurance agencies as well as closing services. The industry players are involved in building single-family detached and attached home communities; townhouses, condominiums, duplexes and triplexes; master-planned luxury residential resort-style golf communities; and urban low, mid, and high-rise communities. The companies are also involved in the purchase, development and sale of residential land. Additionally, the companies build and own multi-family rental properties; residential real estate; and oil and gas assets.

3 Trends Shaping the Homebuilding Industry's Future

Suburban Shift: The changing geography of housing demand has been supporting builder confidence. Demand for new homes is improving in lower-density markets, including small metro areas, rural markets and large metro exurbs, as people seek larger homes to work from home amid the pandemic. The desire for more space and amenities to accommodate working and learning from home should continue to boost the U.S. housing market in the near term.

Cost-Control Efforts, Focus on Entry-Level Buyers & Acquisitions: Given the accelerated raw material prices, the companies have been relying on effective cost control and focusing on making the homebuilding platform more efficient, which in turn is resulting in higher operating leverage. Homebuilders have been controlling construction costs by designing homes efficiently and obtaining construction materials and labor at competitive prices. Some homebuilders also follow a dynamic pricing model, which enables them to set the price according to the latest market conditions.

Also, the majority of companies are focused on growing the demand for entry-level homes and addressing the need for lower-priced homes, given affordability concerns prevailing in the U.S. housing market. Meanwhile, industry players have been acquiring other homebuilding companies in desirable markets, in turn resulting in improved volumes, market share, revenues as well as profitability.

Supply Chain Hurdles, Tight Labor Market & Expected Higher Rates: Continuous supply-chain issues arising from the COVID-19 outbreak and response to the health crisis in various countries have been impacting builders’ ability to deliver on time. Also, rising material costs are quite challenging. According to an Associated Builders and Contractors' latest analysis of information provided by the U.S. Bureau of Labor Statistics, there has been upward pressure on construction input prices in recent weeks. Again, the shortage of skilled labor continues to be a pressing concern. Homebuilders remain cautiously optimistic about the industry’s prospects owing to the rising input and labor costs.

Although the U.S. housing market remains buoyant, defying low inventory levels and broad-based economic as well as public health risks, higher mortgage rates expectation in the near term may mar its prospects. It is to be noted that the Federal Reserve expects to raise interest rates three times in 2022 as it exits from the policies enacted at the start of the health crisis. Interest rate hikes, soaring inflation and a smaller bond-buying program are pointing to higher mortgage rates in 2022. This may prove less encouraging for this rate-sensitive market, which accounts for almost 3% of the economy.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Building Products - Home Builders industry is a 19-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #40, which places it at the top 16% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates upbeat near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s earnings growth potential. Since December 2021, the industry’s earnings estimates for 2022 have increased approximately 7.4%.

Given solid near-term prospects, we will present a few stocks that have the potential to outperform the market. But before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Lags Sector and S&P 500

The Zacks Building Products - Home Builders industry has lagged the S&P 500 Index and broader Zacks Construction sector in the past year.

Over this period, the industry has gained 7.4% compared with the S&P 500’s rise of 18.5% and the broader sector’s 9.9% rally.

One-Year Price Performance

Industry's Current Valuation

On the basis of the forward 12-month price-to-earnings ratio, which is commonly used for valuing homebuilding stocks, the industry is currently trading at 6.32 compared with the S&P 500’s 20.65 and the sector’s 13.74.

Over the last five years, the industry has traded as high as 14.37X and as low as 6.31X, with a median of 9.63X, as the chart below shows.

Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500

5 Homebuilding Stocks to Buy Right Now

We have selected five stocks from the Zacks homebuilding space that currently carry a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Lennar: Based in Miami, FL, Lennar is engaged in homebuilding and financial services in the United States. The company’s dynamic pricing model, asset-light strategy, effective cost control and higher operating leverage have been aiding its performance. Although the rising land, labor and material costs remain headwinds, its focus on the lighter land strategy to boost free cash flow will bolster the balance sheet and thereby drive returns.

Lennar has lost 5% over the past year. The company currently carries a Zacks Rank #1 and has an expected earnings growth of 10.9% for fiscal 2021. The Zacks Consensus Estimate for its fiscal 2022 earnings has moved up 1.4% over the past seven days.

Price and Consensus: LEN



Toll Brothers: Based in Horsham, PA, Toll Brothers is a leading builder of luxury homes. The company has been benefiting from its strategy of broadening the product lines, price points and geographies. Also, it has been gaining from a favorable housing backdrop, lack of competition in the luxury new home market and buyout synergies.

Earnings for Toll Brothers — sporting a Zacks Rank #1 — are expected to grow 49.9% in fiscal 2022. It has gained 5.2% over a year. Toll Brothers has seen an upward estimate revision of 2.5% for fiscal 2022 earnings over the past seven days.

Price and Consensus: TOL



KB Home: This Los Angeles, CA-based homebuilder is well positioned, given a robust backlog level, a strong lineup of community openings and a solid return-focused growth model. With resilient U.S. housing market momentum, backlog value at fiscal fourth quarter-end grew 67% from a year ago to $4.95 billion, marking the highest fourth-quarter level since 2005.

Earnings for KB Home — currently sporting a Zacks Rank #1 — are expected to grow 67.9% in fiscal 2022. It has gained 1.3% over the past year. KBH has seen an upward estimate revision of 28.9% for fiscal 2022 earnings over the past seven days.

Price and Consensus: KBH




D.R. Horton: Based in Texas, this homebuilder offers a diverse line of homes across various price points through a multi-brand platform like D.R. Horton, Emerald Homes, Express Homes and Freedom Homes. Further, the company enjoys one of the broadest geographic diversities in the industry and is not dependent on any particular market. It has a strong presence in 98 markets across 31 states in the East, Midwest, Southeast, South Central, Southwest and West regions of the United States. With 81,965 homes closed in fiscal 2021 for $26.5 billion, D.R. Horton completed its 20th consecutive year as the largest homebuilder in the United States. Impressive performance, industry-leading market share, solid acquisition strategy, a well-stocked supply of land, lots and homes along with affordable product offerings across multiple brands are expected to drive growth.

Earnings for D.R. Horton — presently carrying a Zacks Rank #2 — are expected to grow 27.6% in fiscal 2022. The stock has declined 3.4% over the past year. That said, DHI has seen an upward estimate revision of 0.6% for fiscal 2022 earnings over the past seven days.

Price and Consensus: DHI



PulteGroup: Based in Atlanta, GA, this homebuilder has been benefiting from a prudent land investment strategy, focus on entry-level buyers and returning more free cash flow to shareholders. PulteGroup’s annual land acquisition strategies have been resulting in improved volumes, revenues and profitability for quite some time now. The company has been reaping benefits from the successful execution of strategic initiatives to boost profitability, with a focus on entry-level homes.

PulteGroup stock, carrying a Zacks Rank #2 at present, has dropped 0.9% over the past year. That said, the Zacks Consensus Estimate for its 2022 earnings has been upwardly revised by 0.7% over the past seven days. Earnings for 2022 are expected to grow 23.8%.

Price and Consensus: PHM


Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

D.R. Horton, Inc. (DHI) : Free Stock Analysis Report

PulteGroup, Inc. (PHM) : Free Stock Analysis Report

Toll Brothers Inc. (TOL) : Free Stock Analysis Report

KB Home (KBH) : Free Stock Analysis Report

Lennar Corporation (LEN) : Free Stock Analysis Report

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