What are we looking for?
U.S. home-builder stocks with attractive valuations and return on equity.
According to data from Redfin, a U.S. real-estate brokerage, the median price of U.S. homes soared by 8.9 per cent in March compared with the prior year – the biggest annual increase in four years. Meanwhile, the supply of homes was down 11.9 per cent compared with a year ago. Rising prices and low inventory are bullish for the shares of U.S. home builders, an industry that has struggled so far this year with the SPDR S&P Homebuilders ETF (XHB-NYSE) down more than 11 per cent year-to-date.
The screen
We will be using Trading Central Strategy Builder to search for U.S. home-builder stocks that have reasonable valuations combined with strong return on equity and low debt levels.
We begin by setting a minimum market cap threshold of US$5-billion. This will focus our search on large-capitalization U.S. home-builder stocks whose revenue streams tend to be more predictable than their smaller-cap cousins. We will also limit our search to stocks displaying trailing price-to-earnings ratios of 25 or less.
To select stocks with strong return on equity, we screen for ROE ratios of 10 per cent or more. Only about 25 per cent of U.S. stocks have ROE levels in this range. Finally, to focus on companies with low levels of debt in this rising interest-rate environment, we will also filter to include only companies with debt-to-equity ratios of one or less.
More about Trading Central
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, ETFs, indexes, forex, options and commodities.
What did we find?
After putting in a remarkable performance in 2017, D.R. Horton Inc. has struggled in 2018 and is down about 12 per cent year-to-date. The company has very good return on equity of 14.3 per cent and a reasonable valuation with a P/E ratio of 16.8.
Miami-based Lennar Corp. is the largest home builder in the United States by market cap. The company operates in 17 states and made a new 52-week high on Jan. 22. Since then, fears of rising interest rates have suppressed the stock price, which is down 16 per cent year-to-date.
Toll Brothers Inc. is interesting because of its focus on the U.S. luxury home market. It is the smallest company on our list with a market cap of US$6.2-billion and also has the lowest P/E ratio at 11.7. On Feb. 27, the company announced fourth-quarter earnings that beat analyst estimates for earnings by a wide margin.
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 15.7-per-cent annualized return compared with 11 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.
Peter Ashton is vice-president of customer success at Trading Central.