What are we looking for?
US homebuilder stocks with attractive valuations despite unattractive building costs.
U.S. housing starts have been in a downtrend since peaking almost a year ago at 1.79 million. Housing starts refers to the number of new residential construction projects that have begun during any particular month. March and preliminary numbers for April starts have come in way above expectations at 1.45 million and 1.42 million, respectively, compared with a low of 1.31 million in February. Separately, building permits refers to the approvals given by local jurisdictions before the construction of a new building – or the modification of an existing one – can legally occur. March final U.S. building permit data is expected to be released on April 25, but looking at final data for February, permits rose an impressive 15.8 per cent and marked the first increase since November. The trend of rising housing starts and permits is a positive sign for U.S. homebuilders. We were curious to find out which U.S homebuilder stocks look attractive from a valuation and Quantamental perspective.
The screen
We used Trading Central Strategy Builder to search for U.S. homebuilder stocks indicating attractive valuations and upside price momentum.
We began by searching for stocks exclusively in the homebuilding and construction sectors that have a return on equity of at least 10 per cent to see how effectively management has used invested capital to generate income.
Next, we screened for homebuilder stocks indicating a price-to-earnings ratio at or below the average of the S&P 500 U.S. homebuilding total return index, which sits at a relatively low 6.84. For reference, the P/E of the S&P 500 index is at 18.67.
We focused on companies with low levels of debt amid a higher interest rate environment, capping debt-to-equity at 0.60, The higher the ratio, the more leveraged the company is.
Finally, we screened for companies indicating a TC Quantamental Rating of 6 or higher. The TC Quantamental Rating is a proprietary stock rating methodology developed by Trading Central. This metric rates stocks on a scale of one to 10, with 10 being the most bullish and one being the most bearish. TC Quantamental rating uses a combination of valuation, growth, quality, price momentum, and income factors as key metrics when rating a company.
We have also included annual dividend yield, year-to-date return and one-year return.
More about Trading Central
Trading Central is a global leader in financial market research and investment analytics for retail online brokers and institutions. Its product suite provides actionable trading ideas based on technical and fundamental research covering stocks, exchange-traded funds, indexes, forex, options and commodities. Strategy Builder, our stock screener is available through leading retail brokers in Canada and worldwide.
What we found
Topping our list is U.S. homebuilder PulteGroup Inc. PHM-N. The stock has the highest return-on-equity on our list at 31.7 per cent. Debt-to-equity is one of the lowest on our list at 0.31. The stock is indicating a TC Quantamental rating of 7.16 out of 10, which is very strong. U.S. equities with a TC Quantamental Rating of seven or higher produced a 17.5-per-cent annualized return using a five-year historical period with monthly rebalancing, compared with 8 per cent for the S&P 500 index, according to our research. The stock price reached a record high today after competitor D.R. Horton Inc. just forecast its full-year revenue above analyst estimates, lifting the entire sector higher Thursday morning.
Speaking of D.R. Horton DHI-N, the homebuilder has the highest market cap on our list at 34.98 billion and the lowest Debt to Equity ratio on our list at just 0.21. The company has the second-highest return on equity on our list at 31.67 per cent.
The SPDR S&P Homebuilders ETF (XHB-N) is up 12.63 per cent year-to-date outperforming the S&P 500 index which is up 7.50 per cent in the same period. Momentum is increasing in the homebuilding sector.
Trading Central Strategy Builder provides a backtesting 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 15-per-cent annualized return, compared with 9 per cent for the S&P 500 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.