Were Banks Wrong About the Fate of Stocks Like PulteGroup?

Just a few months ago, analysts at Citigroup and Wedbush decided to take a bearish view of homebuilding stocks, quoting weakness in the construction sector due to headwinds from high mortgage interest rates and inflation-choked U.S. consumers. However, these analysts may have to return to the spreadsheets and adjust to a very different reality.

Stocks like D.R. Horton Inc. (NYSE: DHI) and Lennar Co. (NYSE: LEN) saw their price targets reduced recently. Analysts at Goldman Sachs and, again, Wedbush lowered their targets by nearly 10% on this basket of stocks. What they may not have realized is that these downgrades directly conflicted with Warren Buffett’s positioning in the sector.

Today, as earnings season gets on full swing, shares of PulteGroup Inc. (NYSE: PHM) prove these downgrades to be on the wrong side of history. The stock is not only moving up by roughly three points in the pre-market hours of Tuesday morning, but it is also reacting 2% upward to the company’s stellar second quarter 2024 earnings release. This is what investors need to take away.

PulteGroup Stock Financials Point to a Strong Market

Before investors examine the mechanics of the homebuilding industry and how the macroeconomic picture of the United States economy affects it, they should start with PulteGroup's financial results.

Within the company's quarterly earnings press release, investors can look at the most common driver that affects businesses in every industry: revenue. Pulte's sales saw a 10% jump to reach $4.4 billion this quarter. Now, there's a good and a wrong side to this jump.

Inflation in the economy also affects the housing market, and rising home prices can play a part in Pulte's rising revenue levels, but that's not the only reason revenue grew for the company. Home sale gross margins rose by 30 basis points to 29.9% this quarter, disproving the inflation argument.

If inflation is the cause of revenue increase, then inflation would also be to blame for rising building costs. Rising gross margins would cancel that trend and lead investors to demand-driven jumps in revenue. But with U.S. home building permits down by 7% on the year, where is demand really coming from?

According to Zillow Group Inc. (NASDAQ: Z), some markets have seen a year-on-year jump in housing shortage rates, particularly in Florida and Texas. For those who know, this is great news for Pulte. For those who don't, Pulte's primary market is in the Sunbelt region (Florida and Texas).

Knowing there is rising demand for new housing inventory in the company's main markets, it shouldn't be surprising to learn that net earnings per share (EPS) also jumped by 19% to reach $3.83 this quarter. However nice this may be, it's all in the rear-view mirror, which can't be monetized.

The road ahead is what can be monetized, and this is what that looks like for PulteGroup. Net new orders reached 7,649 for a total value of $4.4 billion today. In comparison, the unit backlog of 12,982 homes shows investors a value of $8.1 billion, which will be realized upon delivery as revenue.

Future Forecast: What's Ahead for PulteGroup Stock?

Building from the company’s rising backlog valuations and new orders ahead, investors can start to decrypt the market’s message regarding the future of PulteGroup stock. From the inside out, knowing what the company is doing with its $600 million in free cash flow for the quarter is a good indicator.

PulteGroup management used up to $314 million to buy back stock off the open market, sending a message to the entire market. The message is that management believes the stock is undervalued today, even as it trades at 97% of its 52-week high, and who better to know this than insiders themselves?

Markets do feel like this outlook is within base reality, and there are ways to check for that, too. Investors can scan for valuation spreads to pinpoint the outliers. Here’s where PulteGroup stands against its peer group on a price-to-book (P/B) basis.

Trading at 2.2x P/B means PulteGroup commands a premium of 12.6% above D.R. Horton’s 1.9x valuation multiple. The trend continues when investors look to Lennar’s 1.5x valuation to make PulteGroup 39.6% more expensive than its competitor.

When stocks trade near their 52-week highs and at premiums over peers, it is typically due to good reasons. Analysts at Evercore came to give investors a contrarian view by slapping a $189 valuation on PulteGroup stock, daring it to rally by 50.4% from where it trades today.

The article "Were Banks Wrong About the Fate of Stocks Like PulteGroup?" first appeared on MarketBeat.