Turnaround? Downturn? Oh, What a Mess!

Whoa! When was the last time you saw a chain of battered homebuilder stocks zoom up by 10% or more? Just one data release sent the stocks into a tizzy yesterday and must have left many of you wondering what to make of it.

The National Association of Home Builders/Wells Fargo Housing Market Index rose four points, to 18, in October, the highest one-month gain in more than a year. The index, which gauges buyer perceptions and sentiments, is now indicating more buoyant consumer confidence, which is why the stocks shot up.

So now, my dear Fools, are your fingers tickling to get into one of these bashed-up stocks? Are things really turning around for the sector?

Some positive signs
Homebuyers are slowly trickling back into the market. How do we know that? Higher orders and healthier backlogs.

Most companies are showing improvement in these two areas. Take the last-reported quarters, for instance. Lennar (NYSE: LEN  ) reported an 11% rise in new home orders in its third quarter, while Hovnanian Enterprises' (NYSE: HOV  ) net contracts rose by 33% in the quarter. Beazer Homes' (NYSE: BZH  ) third-quarter net new orders were up by 24%, and the company has recently announced a 33% jump for its fourth quarter. Not too shabby.

Backlogs are an important indicator of future revenues for homebuilders. KB Home's (NYSE: KBH  ) and Toll Brothers' (NYSE: TOL  ) third-quarter backlogs were up a good 22% and 9%, respectively, while Pulte Group's (NYSE: PHM  ) second-quarter backlog rose by 2%. To know that these companies are now having more work in hand is indeed a positive sign.

Hello, buyer, are you there?
Poor homebuilders! They've been trying all kinds of things to stay ahead. Beazer's trying the buying-and-renting-foreclosed-homes strategy, and Lennar is keen to follow suit.

D.R. Horton (NYSE: DHI  ) is rolling out new solar roof shingles, and builders like Standard Pacific (NYSE: SPF  ) and KB are coming up with innovative architectural designs and energy-efficient homes.

But where are the buyers?

Consumer spending is in the doldrums. August new house sales fell 2.3% sequentially, with only 295,000 homes being sold -- the weakest in six months. Almost 80% has been chewed off from the 2005 new homes sales peak.

Mortgage rates are rock-bottom now, but who knows when housing prices will actually touch the floor? When low mortgage rates have failed to boost orders, imagine what happens if housing prices slip further. Unless more houses sell, lower prices will continue to crush homebuilders' top lines.

As long as unemployment rates remain high, and with a cloud of economic uncertainty looming large, buyers will be wary of putting their money into home shopping. Add stringent lending norms, and doubts multiply. It's a vicious circle, with no end yet in sight.

The mad price/demand mess
But there's something you must know before jumping to any conclusions. Fool colleague Morgan Housel has pointed out what could be the key driver fueling a housing recovery: the inventory situation.

Currently, new house construction is lying low, and the existing inventory is burning down quite fast. That's because, with buyer sentiments still weak, there are more homes already up than there are buyers. But this situation can't last forever, with new households being formed all the time.

Eventually, demand will catch up with supply, and prices are bound to move up. The equation then becomes as simple as high demand + high price = high revenues. The only concern is that no one can really say how long we might have to wait to see this equation become a reality.

The Foolish bottom line
When it comes to investing our hard-earned money, we Fools are wise enough not to get distracted by a single piece of news. However, it is crucial to know that some important metrics have been showing signs of improvement.

One thing's for sure. This news has sparked my interest in homebuilders, and I'm eager to see what the latest quarterly numbers will tell us. If the numbers turn out to be juicy, well then, we might be looking at an industry that has been bashed up black and blue, but which could prove to be worth our green in the future!

Check back at fool.com to follow our coverage of the homebuilders, and click the links below to add these stocks to your stock watchlist, which brings you Foolish news and analysis.

Neha Chamaria does not own shares of any of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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