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Where Next, Toll Bros.?

This morning, Toll Brothers (NYSE: TOL  ) , the nation's leading builder of luxury homes, reported record earnings and handily beat Wall Street's expectations. Contracts for new home purchases and backlog were the highest for any quarter in company history, while net income and revenues set July quarter records.

Who'd expect anything less with mortgage rates at multi-decade lows? Toll investors are rightly wondering, can it get any better than this -- or for that matter, even stay this good?

There is, of course, no way of knowing what direction interest rates and the economy will take, but it would be foolhardy to assume that ideal conditions will persist indefinitely for Toll and the homebuilders. This line of thinking explains why the stock is down 2% today.

The opposite line of thinking, however, is that global deflationary forces can in fact keep mortgage rates low and housing strong. And this, during a time when retiring baby boomers are interested in buying second homes for vacation purposes. Toll Brothers, for its part, is planning for precisely this growth scenario.

In today's release, Robert I. Toll, CEO and chairman, stated: "We are on pace for record results in 2003 and, it appears [emphasis mine], for the next several years to come... In fiscal 2004 we project a rise of approximately 20% in our new home deliveries and we plan to increase our selling communities from 185 today to approximately 205. With our expanding lot supply, we believe we are positioned for significant growth through at least 2006."

Can Toll deliver on this promise? Its valuation implies a belief that it can. At $29, the company is valued at 8.6 times expected earnings of $3.37 for the year ending in October. That's only slightly less than Toll's seven-year average P/E of 9.3, suggesting that its current price isn't discounting any sort of earnings downturn. In contrast, as recently as March, skepticism towards Toll's outlook had brought the shares as low as 6.0 times earnings.

But now that there's less skepticism priced into Toll's valuation, the risk is all the higher for buyers at current levels. It's precisely when no one is expecting a real estate crisis that one is most likely.

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10/24/2016 4:03 PM
TOL $28.76 Up +0.23 +0.81%
Toll Brothers CAPS Rating: ***