Three Homebuilding Stocks Set to Lay the Foundations for Growth

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This week, we use AAII’s A+ Investor Stock Grades to provide insight into three homebuilding stocks. With the growing demand for new homes, should you consider the three homebuilding stocks of D.R. Horton Inc. (DHI), PulteGroup Inc. (PHM) and Toll Brothers Inc. (TOL)?

Homebuilding Recent News

The homebuilding market is currently experiencing significant growth due to a shortage of existing homes for sale and strong demand for new homes. This trend is largely driven by current homeowners who want to retain their low mortgage rates, leading them to hold onto their properties. As a result, buyers are increasingly turning to new constructions. Lennar Corp. (LEN), one of the nation’s largest homebuilders, reported a nearly 20% increase in new-home orders for second-quarter 2024, demonstrating the rising demand for newly constructed homes.

Traditionally, new-home sales have accounted for approximately 10% to 12% of the housing market, according to the National Association of Realtors. However, recent research from Redfin Corp. (RDFN) highlights that newly constructed homes now constitute one-third (33.4%) of the total housing inventory nationwide, nearing a record high.

Considering these developments, the homebuilding sector presents promising investment opportunities as competition among buyers has intensified. Homebuilders are strategically capitalizing on the current trend by offering attractive incentives such as mortgage rate buydowns and customization options that existing homes often cannot match. Companies like D.R. Horton, PulteGroup and Toll Brothers may be well-positioned to capitalize on these current trends.

Grading Homebuilding Stocks With AAII’s A+ Stock Grades

When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is why AAII created the A+ Stock Grades, which evaluate companies across five factors that research and real-world investment results indicate to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.

Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three homebuilding stocks — D.R. Horton, PulteGroup and Toll Brothers — based on their fundamentals.

AAII’s A+ Stock Grade Summary for Three Homebuilding Stocks

What the A+ Stock Grades Reveal

D.R. Horton Inc. (DHI) is a homebuilding company primarily focused on acquiring and developing land, as well as constructing and selling residential homes. The company operates through several segments: homebuilding, rental, Forestar Group Inc. (FOR), financial services and other. The homebuilding segment is responsible for designing, building and selling single-family detached homes on both self-developed and fully developed lots ready for construction. The rental segment includes single-family and multifamily rental operations, where single-family homes are constructed and leased within a community before being marketed for bulk sale. The Forestar Group segment specializes in residential lot development. The financial services segment offers mortgage financing, title agency services and title insurance to homebuyers in many of the company’s homebuilding markets and engages in insurance-related activities.

The company has a Value Grade of B, based on its Value Score of 64, which is good value. Higher scores indicate a more attractive stock for value investors and, thus, a better grade. The Value Grade is the percentile rank of the average of the percentile ranks of the price-to-sales (P/S) ratio, price-earnings (P/E) ratio, price-to-book-value (P/B) ratio, price-to-free-cash-flow (P/FCF) ratio, shareholder yield and the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA).

D.R. Horton has a rank of 21 for shareholder yield and 22 for the price-earnings ratio. The company has a shareholder yield of 4.1% and a price-earnings ratio of 9.6. The enterprise-value-to-EBITDA ratio is 8.5, which translates to a rank of 37.

A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the Quality Grade shows that stocks with higher grades, on average, outperformed stocks with lower grades from 1998 through 2019.

The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.

D.R. Horton has a Quality Grade of A, with a score of 87, which is very strong. The company ranks strongly in terms of its return on assets and F-Score. The company has a return on assets of 15.0% and an F-Score of 6. The F-Score is a number between 0 and 9 that assesses the strength of a company’s financial position. It considers the profitability, leverage, liquidity and operating efficiency of a company.

D.R. Horton has a Momentum Grade of C, based on its Momentum Score of 58. This means that the stock’s momentum is average in terms of its weighted relative price strength over the last four quarters. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters, with the most recent quarterly price change given a weight of 40% and each of the three previous quarters given a weight of 20%. The ranks are 38, 65, 90 and 42, sequentially from the most recent quarter.

PulteGroup Inc. (PHM) is a homebuilder in the U.S. with segments including homebuilding and financial services. The homebuilding operations involve acquiring and developing land primarily for residential purposes and constructing housing on such land, divided into six regions: Northeast, Southeast, Florida, Midwest, Texas and West. The financial services segment primarily consists of mortgage banking, title and insurance agency operations conducted through Pulte Mortgage LLC and other subsidiaries. Pulte Mortgage arranges financing through the origination of mortgage loans primarily for the benefit of its homebuyers. Through its brands such as Centex Homes, Pulte Homes, Del Webb, DiVosta Homes, John Wieland Homes and Neighborhoods and American West Homes, the company offers a variety of home designs to its customer groups, with varying levels of options and amenities.

Earnings estimate revisions indicate how analysts view a firm’s short-term prospects. PulteGroup has an Earnings Estimate Revisions Grade of C, based on a score of 47, which is neutral. The grade is based on the statistical significance of its latest two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.

PulteGroup reported a positive earnings surprise of 31.2% for the first quarter of 2024, and in the prior quarter reported a positive earnings surprise of 1.8%. Over the last month, the consensus earnings estimate for the second quarter of 2024 has increased slightly from $3.267 to $3.268 per share, based on one upward revision. Over the last month, the consensus earnings estimate for full-year 2024 has increased slightly from $13.006 to $13.009 per share, based on one upward revision.

The components of the Growth Composite Score consider a company’s success in growing sales on a year-over-year and long-term annualized basis and its ability to consistently generate positive cash from its core operations. PulteGroup has a Growth Grade of A, which is very strong. The company has a five-year annual sales growth rate of 9.5% and its sales have increased year over year for the past five consecutive years. Cash from operations has been positive in the past five consecutive years.

PulteGroup has a Momentum Grade of B, based on its Momentum Score of 77, which is strong. Its weighted relative price strength ranks over the last four quarters are 50, 76, 90 and 56, sequentially from the most recent quarter. The weighted four-quarter relative price strength is 1.5%.

The company has a Value Grade of B, based on its Value Score of 72, which is good value. PulteGroup’s shareholder yield is 5.7%, which ranks in the 15th percentile among all U.S.-listed stocks. Additionally, PulteGroup’s price-earnings ratio is 8.8, which ranks in the 19th percentile and compares to the sector median of 18.1. These favorable ratios suggest that PulteGroup’s stock may be relatively cheap compared to similar companies in its sector.

Toll Brothers Inc. (TOL) is a builder of luxury homes, designing, building, marketing, selling and arranging financing for a variety of luxury residential properties, including single-family detached homes, attached homes, master-planned communities and urban low-, mid- and high-rise communities. The company operates its own subsidiaries for architectural, engineering, mortgage, title, land development, insurance, smart home technology and landscaping services. Additionally, Toll Brothers develops master-planned and golf course communities and, in certain regions, manages its own lumber distribution, house component assembly and manufacturing operations. The company also caters to urban and suburban renters under the brand names Toll Brothers Apartment Living and Toll Brothers Campus Living. Through Toll Brothers City Living, it designs, builds, markets and sells high-density, high-rise urban luxury condominiums in collaboration with third-party joint venture partners. Toll Brothers operates in approximately 24 states and the District of Columbia.

Toll Brothers has a Quality Grade of B, with a score of 80, which is strong. The company’s return on assets is 12.5%, for a rank of 92. Its buyback yield is 5.8%, for a rank of 92.

Toll Brothers has a Momentum Grade of B, based on its Momentum Score of 79, which is strong. Its weighted relative price strength ranks over the last four quarters are 44, 83, 91 and 56, sequentially from the most recent quarter. The weighted four-quarter relative price strength is 2.2%.

Toll Brothers has an Earnings Estimate Revisions Grade of B, based on a score of 71, which is positive. The company reported a positive earnings surprise of 9.9% for its second fiscal quarter of 2024 ending in April, and in the prior quarter reported a positive earnings surprise of 26.3%. Over the last month, the consensus earnings estimate for fiscal third-quarter 2024 ending in July has increased from $3.330 to $3.325 per share despite only one upward revision and 13 downward revisions. (The estimate is down from $3.391 per share three months ago.) Over the last month, the consensus earnings estimate for fiscal-year 2024 ending in October has increased from $14.067 to $14.172 per share, reflecting 16 upward revisions.

Toll Brothers has a Value Grade of A, with a score of 84, which is deep value. It ranks in the 13th percentile in terms of its shareholder yield and the 15th percentile in terms of its price-earnings ratio.

The company’s Growth Grade is B, which is strong. Toll Brothers has generated positive annual cash from operations in the past five fiscal years and has a five-year annual sales growth rate of 6.9%.

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The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.

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