Three Hot Homebuilder Stocks
This week, we use AAII’s A+ Investor Stock Grades to give you insights into three major U.S. homebuilder stocks benefiting from growing demand for new homes. For investors focused on a surge of buyers who are taking advantage of the lowest financing rates in a generation, major homebuilder stocks Meritage Homes Corp., Taylor Morrison Home Corp. and Toll Brothers Inc. may help build your portfolio.
Build It and They Will Come
Buyers are being pitted against buyers. With new home lots in metro areas across the U.S. in short supply and with demand (and prices) soaring, it is not uncommon to hear sales agents remark that the housing market is “just nuts” when discussing residential real estate over the last year. Demand is simply outpacing supply.
The housing market remains very strong, driven by a tight supply of new and existing homes for sale, favorable demographic trends, low mortgage rates and a heightened appreciation for home ownership. However, building sites are in short supply, the cost of materials is soaring and there’s a shortage of skilled labor to meet this tremendous demand. Builders are working at a feverish pace to keep up.
The upcoming summer months are normally the seasonal peak period for homebuilding, but housing demand has remained buoyant for the last few quarters as well. Analysts think the pandemic has triggered a multi-year secular shift to a new normal in housing in most suburban markets.
During the first quarter of 2021, U.S. housing economic data has shown continued strength in new housing sales, housing starts and permits, as well as home deliveries. On Thursday, April 29, Freddie Mac said the average 30-year fixed-rate mortgage was just 2.98%, about a quarter percentage point below last year at this time.
CFRA Research equity analyst Kenneth Leon wrote in a research report this week, “We think homebuilders are at an advantage to raise prices given the all-time low of U.S. existing home inventory as well as the large demand of millennials who are financially able to own a home with low rates and savings built up. Most homebuilders have an order backlog that can produce solid home deliveries in 2021.”
Grading Leading Homebuilder Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown 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 major homebuilder stocks — Meritage Homes, Taylor Morrison and Toll Brothers — based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Major U.S. Homebuilder Stocks
What the A+ Stock Grades Reveal
Meritage Homes (MTH) designs, builds and sells single-family homes from entry-level to semi-custom luxury in Arizona, California, Colorado, Florida, Nevada, North Carolina and Texas. Meritage Homes is targeting 11,500 to 12,500 total home closings across its 235 to 250 selling communities that could generate up to $4.6 billion in 2021 total home sales.
Meritage Homes has a Value Grade of A, based on its score of 7, which is considered deep value. The company’s Value Score ranking is consistent across several traditional valuation metrics, with a score of 10 for the price-earnings ratio, 18 for the price-to-sales ratio and 19 for the price-to-free-cash-flow ratio (remember, the lower the score the better for value). Successful stock investing involves buying low and selling high, so stock valuation is an important consideration for stock selection.
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the enterprise-value-to-EBITDA (EV/EBITDA) ratio, price-to-book-value ratio and shareholder yield.
Meritage Homes has created an attractive business model focused on selling entry-level homes in Sun Belt markets. The company is also building more speculative homes without customer contracts in these communities. The company is selling more speculative homes before completing construction for quick move in, and the result is a faster pace for home deliveries that boosts its homebuilding revenue.
Estimate revisions offer an indication of what analysts are thinking about the short-term prospects of a firm. Meritage Homes’ Estimate Revisions Grade is A, which is considered very positive. The grade is based on the statistical significance of its last 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.
Meritage Homes has posted earnings surprises of 18.2% and 39.8% for its last two fiscal quarters, mainly due to strong entry-level and move-up homebuyer demand.
In addition, over the last month, the consensus estimate for the fiscal year ending December 31, 2021, has risen 2.2% and there have been two upward revisions to the fiscal-2021 estimate and one downward revision.
Taylor Morrison (TMHC) is a leading national homebuilder and developer that serves a wide range of consumer groups across the U.S. The company operates under the Taylor Morrison and Darling Homes brand names. It also provides financial services to customers through its mortgage subsidiary, Taylor Morrison Home Funding LLC and title insurance and closing settlement services through its title company, Inspired Title Services LLC.
The builder is targeting total communities of 330 in the second quarter of 2021, with 360 average communities in 2021 as it made $552 million in first-quarter land acquisitions to drive growth in the second half of the year. At the end of 2020, Taylor Morrison’s land portfolio included the potential for 70,000 future home sites, representing 5.5 years of supply.
The company’s long-term strategy is focused on pursuing core locations, building distinctive communities, maintaining a cost-efficient company and balancing price with pace in the sales of its new homes.
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the quality grade shows that stocks with higher quality grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
The 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, 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.
Taylor Morrison has a Quality Grade of B, putting it near the top tier among all U.S.-listed stocks. The company ranks highly in terms of its return on assets and F-Score, ranking respectively in the 79th and 77th percentile of all U.S.-listed stocks. However, it ranks poorly in terms of its return on invested capital, only in the 30th percentile.
Toll Brothers (TOL) is a luxury homebuilder with 309 communities under development. It has a strong presence in the U.S. in coastal, mountain and Sun Belt markets. It primarily serves affluent “move-up” buyers and “empty-nesters.” It uses subcontractors to perform all construction and site improvement work on a fixed-price basis.
In the first quarter of fiscal-year 2021, net orders increased 68% and the value of the backlog finished the quarter at over $7.4 billion, up 37% with 8,888 units. Toll Brothers spent $195 million on land to purchase 2,095 lots; management plans to grow total communities from 309 to 320 at the end of second quarter 2021.
Toll Brothers has a strong A+ Growth Grade of B. The growth grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow.
The company has exhibited strong growth over the past year. Sales increased 17.4% year over year for the quarter ending January 31, 2021, while operating cash grew over 115.1%. In addition, Toll Brothers managed to boost earnings by 86.1%.
Toll Brothers has a Momentum Grade of C, based on its Momentum Score of 60. This means it ranks in the middle of the pack of all stocks in terms of its weighted relative 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.
Toll Brothers CEO Douglas C. Yearley Jr. said, “We have luxury communities in desirable locations in both high-growth and high barrier-to-entry markets where our tremendous brand, broad range of home price points and unique build-to-order model give us a competitive advantage. In addition, our extensive geographic footprint and deep land position will allow us to grow community count in fiscal-year 2021 and 2022, even as we sell out of existing communities faster than anticipated and deliver the most homes in our history in fiscal year 2021.”
After holding its dividend consistent in 2019 and 2020, Toll Brothers increased its quarterly dividend in March 2021 by nearly 55% from $0.11 per share to $0.17 per share.
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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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