We have written at great length about the resurgence of homebuilding in the United States. Like any other sector, if you go long enough without production, demand catches up with supply. Doomsday scenario forecasters in recent years were saying that the American dream of owning a home is over. Demand has caught up with the lack of supply, and while the homebuilding sector is on fire, some Wall St. firms are starting to become more cautious.

The analysts at Deutsche Bank A.G. (NYSE: DB) are the most recent on Wall St. to raise price targets on their Buy-rated homebuilding stocks. For the past 12 to 15 months, they contend that investors have been squarely focused on gross margins as the most important differentiating factor among builders. This was driven by the belief that home prices were set to rise more than was commonly expected. Gross margins remain a primary focus; however, there has been a distinct shift after builders released their fourth-quarter results, when investors began to focus more on growth potential as well. Gross margin trends have begun to converge, and with investor expectations so high, margins alone are not enough to drive earnings.

Investor expectations are indeed high, and a contrast is starting to emerge as just yesterday Barclays PLC (NYSE: BCS) downgraded four homebuilder stocks from Overweight to Neutral. They still like the sector but are cautious after big stock price moves. So the question for investors starts to become one of valuation. The question also becomes one of determining where the builders are in the cycle.

Overall most of the builders reported positive results this quarter. The Deutsche Bank research shows that 70% of the builders beat expectations while only 20% were in line and just 10% missed expectations. The builders generally performed well in gross margins, which is of tantamount importance to investors after strong stock performance. And 90% of the builders showed upside on gross margins in their fourth quarter results. Order growth also was generally strong this past quarter, with a median of 35% year-over-year growth, which is higher than consensus forecasted 29% growth. 90% of the builders were
either in line or above consensus on order growth.

Deutsche Bank raised their price targets on four stocks that it rates with Buy ratings and one rated Neutral. Top pick D.R. Horton Inc. (NYSE: DHI) has its price target raised from $22 to $25. The Wall St. consensus price target is also $25. MDC Holdings Inc. (NYSE: MDC) is rated Buy and its price target goes from $44 to $45, and the consensus target is $39.25. Meritage Homes Corp. (NYSE: MTH) jumps from $42 to $46 with a Buy rating. The Thomson/First call estimate is $44. The last Buy-rated name, Ryland Group Inc. (NYSE: RYL), has its price target raised to $42 from $38. The consensus target is $40. Neutral-rated PulteGroup Inc. (NYSE: PHM) is upped from $15 to $17, and the consensus is $20.

Mortgage rates that continue to be at historical lows, combined with an economy that appears to be slowly but surely improving, should continue to provide a tailwind for the industry. After almost three years since hitting their lows in March of 2009, the homebuilding stocks have been one of Wall St.’s top-performing sectors. The challenge for investors at this point is not only choosing the right name, but picking the right entry point. One good way to add the sector to a well-rounded portfolio is to buy the SPDR S&P Homebuilders ETF (NYSEMKT: XHB). This adds diversification by offering a basket of the top stocks in the sector.

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