Housing
One Amazing Trade Has Outperformed the S&P 500 in 9 of the Past 10 Years
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If there is one specific metric that Wall Street analysts love, it is historical performance, and why not? You can take all the other analytics and number crunching and none of it compares with it, and with good reason. Historical trends tend to develop and happen because the set-up for the trend to unfold on an annual basis essentially remains the same every year. When that does happen, you can make a strong case it will happen again.
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The analysts at Raymond James have found an incredible trade, which they dubbed the “Hope Trade,” and the numbers don’t lie. They explained the parameters in a new research report:
The “Hope Trade” keeps delivering. The seasonal “Hope Trade” in the U.S. homebuilding sector continues to be perhaps the most consistent and powerful cyclical trading phenomenon we’ve seen among any industry group in the market. While no trading strategy is ever 100%, the homebuilders’ historical track record of seasonally timed outperformance versus the S&P 500 remains unparalleled. The success rate has been remarkable, including: 1) 27 of the past 35 years; 2) nine of the past 10 years; and 3) successful outperformance whether interest rates are rising or falling (though falling rates do provide a stronger tailwind). According to our updated historical data on publicly traded homebuilders, this seasonal trade has produced an average outperformance of +13% (1,340 basis points) vs. the S&P 500 over the past 35 years.
While it seems counterintuitive, as most people think spring and summer selling season is the most critical time for homebuilders, the reality is that now is the time when the trade needs to be put on, and the analysts explained why:
The underlying strategy behind the “Hope Trade” is to own the homebuilders for two discrete events: 1) the beginning of third quarter earnings season, which starts in the latter half of October (defined as October 16 here) and 2) the first week or so of fourth quarter earnings season (through the end of January). Coincidentally, this also usually lines up with Super Bowl weekend (first Sunday in February) and the official beginning of the “spring selling season.” The rationale for this includes 1) new home order backlogs for the year are largely complete by mid-October, creating more focus on the year ahead, 2) Fourth quarter earnings are usually the builders seasonally strongest of the year due to the timing of home deliveries, and 3) management and investor optimism frequently reaches “peak hope” as the fourth earnings season is winding up, with a fair amount of positive anecdotes about early homebuyer interest drawing disproportionate attention. Moreover, given its long term success rate and a likely increasing amount of algorithmic trading looking for repeating market patterns, in some cases we suspect there is a “self-fulfilling” element to the pattern.
The Raymond James analysts do not have a blanket buy on the entire sector. Instead, they are focused on four top companies that have the firm’s highest ratings. All are solid selections for growth investors with a degree of risk tolerance.
KB Home
This very well-known company could be acquired in any industry consolidation. KB Home (NYSE: KBH) is one of the largest U.S. homebuilders, with roughly 2% market share. The company builds single-family homes, townhomes and condominiums for first-time, move-up and active adult buyers. It is positioned in roughly 40 markets, with around 70% to 75% of revenues attributable to the West and Central regions. It also provides mortgage services through a joint venture with Nationstar.
Founded in 1957, and the first homebuilder listed on the New York Stock Exchange, the company has built nearly 600,000 homes for families from coast to coast. Distinguished by its personalized homebuilding approach, KB Home lets each buyer choose their lot location, floor plan, décor choices, design features and other special touches that matter most to them.
Shareholders receive a 1.00% dividend. Raymond James has an Outperform rating with a $38 price target, while the Wall Street consensus target is $36.38. The stock closed on Monday at $36.24.
Lennar
This company is very well set in the entry-level market, and the shares are also rated Outperform at Raymond James. Lennar Corp. (NYSE: LEN) is the second-largest public homebuilder by closings in the United States, delivering over 49,000 homes in 2018. The company is well positioned in 21 states in 49 markets in four major regions, targeting first-time, move-up and active adult buyers.
Lennar has diversified its core homebuilding operations with the addition of real estate investment and management, multifamily and single-family, and commercial real estate development in California. The company also owns a financial services business.
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Lennar offers investors just a 0.26% dividend. The Raymond James price target is $65, and the consensus target is $62.19. The stock closed at $61.02 on Monday.
M.D.C.
Despite having somewhat lower name recognition, this stock is rated at Strong Buy at Raymond James. M.D.C. Holdings Inc. (NYSE: MDC) is a top 15 builder in the United States based on deliveries, with approximately 6,200 homes delivered in 2018.
The company is positioned in around 20 markets in nine states and targets first- and second-time move-up buyers with some entry-level exposure. It primarily builds single-family detached homes under the Richmond American Homes brand. The company also owns a financial services business that provides mortgage financing, title, insurance and closing services.
The company has subsidiaries with homebuilding operations across the country, including the metropolitan areas of Denver, Northern Colorado, Colorado Springs, Salt Lake City, Las Vegas, Phoenix, Tucson, Riverside-San Bernardino, Los Angeles, San Diego, Orange County, San Francisco Bay Area, Sacramento, Baltimore, Orlando, Jacksonville, Seattle and Portland.
Shareholders receive a 2.62% dividend. The $49 Raymond James price target compares with the $43.50 consensus estimate. The stock closed at $45.84.
Toll Brothers
This company focuses more on the higher end of the market, and business remains good. Toll Brothers Inc. (NYSE: TOL) is a leading U.S. homebuilder with a focus on luxury suburban and urban markets. It operates in four distinct geographic segments, building homes catering to move-up, empty-nester, active-adult and second-home buyers.
Toll Brothers has entered into various joint ventures to develop land or high-rise construction projects. More than 45% of the company’s sales are attributable to the Northeast and Mid-Atlantic regions.
Shareholders receive a 1.09% dividend. The Raymond James Outperform rating comes with a $45 price target. The consensus target is $39.38, and shares closed at $40.38.
These four stocks have some remaining upside to their current respective targets, which could be moved higher. With the mortgage interest deduction levels for tax purposes raised, the great majority of the homes sold by these companies will be eligible for the deduction. In addition, if mortgage rates continue to stay at the current historically low levels, sales should continue to move higher, possibly much higher.
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