Wednesday, April 11, 2007

Recovery for homebuilder's stocks?

Homebuilder's stocks continue to decline precipitously. When do they hit their bottom and begin a recovery? Remember perhaps in the fall of 2002 when, in the midst of the Enron and Worldcom debacles and after the meltdown of private equity tech investments, JP Morgan Chase was trading below $20. Within a year the stock was in the high 20's and today it's around $50. It's easy in hindsight to see a bottom and, as with big banks at that time, it will come for the stronger homebuilders.

Trying to call this bottom is dangerous, actually impossible, but different points of view make a market. Today I bought a little KB Homes, last week some Centex, and yesterday added to Hovnanian. This may be foolhardy, and telling others about it may be just plain stupid. But anyway, a few facts on these three.

Each has been in business since the 1950's, has experienced management and staff that has been through the ups and downs of real estate for over 50 years, and have top ten shareholder lists that would be the envy of most firms in any industry(meaning people who have exceptional track records in investing are major shareholders in each of these firms). Centex is certainly a residential leader but it also has a significant business in construction of hospitals, educational buildings, airport facilities and office buildings. It's two year high is around 80 and now it's at 42. Hovnanian is a residential builder diversified across 48 states, of the three stocks has had the most conservative inventory build, and it's two year high was 73 and now it's trading below 23. KB Homes is residential but also has a commercial division and had a two year high of 85 and it now trades around 41. It was reported today that Fidelity Investments raised its stake in the company from 7.5% of shares to 15% in the last month or so.

Stocks of course can go to zero so why take comfort in these numbers. Real estate downturns can take years to unwind as in the residential stagnation that went on from 1990 until about 1994. More inventory write-downs may be probable for these firms as well. Good points by my alter-ego, but the other side of this coin is as follows. The leaders in businesses with experienced management teams tend to weather storms and come back even stronger over a period of time because weaker or less disciplined competition gets winnowed out. Like banks, housing is pretty much a necessary part of our economic infrastructure long term. Timing a bottom is not possible, so modest individual bets diversified among the best in the business is a reasonable way to play this, one could think.

Finally, as troubling as the mortgage market issues are and will continue to be for some time, they are being worked out as they should be. Bad lenders are folding, bad products are being removed from the market, portfolios are being sold at discounts, well-managed sub-prime lenders are able to get back up financing, inventories are being managed in related industries, major financials are relatively unscathed, and U.S. employment remains strong.

The market always discounts the future. There's a lot of really bad stuff already in the stock prices of CTX, HOV, and KBH. If things get worse, these stocks will likely go down but so will stocks in many other industries. If stocks are part of a portfolio, an allocation to names like these is now a reasonable option, PERHAPS?

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