The stock market is in rally mode through the first half of January -- Greek debt woes be damned! For optimists, these rallies may seem like a dream come true. For skeptics like me, they're opportunities to see whether these companies have actually earned their current valuations.
Keep in mind that some companies do deserve their current valuations. Home improvement stores Home Depot (NYSE: HD ) and Lowe's (NYSE: LOW ) are both tipping the scales at new 52-week highs as homeowners are choosing to remodel their homes rather than risk purchasing a new home. For Lowe's, 2011 marked a record year in sales. For Home Depot, it's setting the stage for the second straight gain in revenue after a big skid from 2007 to 2010.
Still, other companies might deserve a kick in the pants. Here's a look at three companies that could be worth selling.
Taking a Toll
This week, I'll be focusing solely on the homebuilding sector, which has rallied seemingly from out of nowhere. First up is higher-end builder Toll Brothers (NYSE: TOL ) .
Outside of the fact that Toll is trading at 98 times trailing 12-month earnings and 75 times its cash flow, everything is just peachy (note: that was sarcasm). I can point to some of the good aspects of Toll's 2011 campaign, which included an increased backlog, higher selling prices, and a second consecutive quarterly profit. But beyond that, the fact remains that selling prices, while up, are hardly budging across the United States, and the only reason Toll even turned a profit was because it excluded a $92.7 million inventory and joint-venture writedown. As Toll's management noted, housing starts are down 60% from their peak, so shareholder expectations should be tempered as well. I'd hardly call 33 times forward earnings tempered, and I'd be a seller of Toll here.
If you build it, they will run
Ryland Group (NYSE: RYL ) is another case where you have to look past the initial numbers to see what's really going on.
In the third quarter, Ryland recorded a 30% rise in new orders and a 26% jump in backlog with average selling prices rising a moderate 2% over the year-ago period. However, if you back up and look at Ryland's results for the first nine months of fiscal 2011, you'd see a company that's lost $1.16 per share on a 20% drop in homebuilding revenue.
Perhaps more concerning, Ryland has $178 million less in cash than it did at this time last year. Ryland hasn't turned an annual profit since 2006 and has badly missed Wall Street's expectations over the past four quarters. At 55 times 2012's profit projections, I think you can do much better with your money.
The third little pig
I wouldn't mind if the big bad wolf came and blew PulteGroup's (NYSE: PHM ) house down, because its valuation makes the least sense of all.
Despite losing money in each of the past five years and witnessing sales fall by about 70% in that period, shareholders have pumped Pulte to 1.6 times its book value. Unlike Toll and Ryland, Pulte's net orders were flat in the third quarter and its average selling price actually fell 1% year-over-year! Pulte's cash balance has also shrunk by 50%, to $1.1 billion from $2.6 billion at this time last year. In a highly competitive marketplace that simply doesn't have any room for second-tier companies, Pulte has proven again that it is the weakest link.
Time and time again, I've sounded off on my dislike for the housing sector, and these three companies finally reached a valuation worth taking action on. I'd hardly call these "less-bad" results any reason to celebrate and neither should you. I'm so confident in my three calls that I plan to make a CAPScall of underperform on each one. The question now is: Would you do the same?
Share your thoughts in the comments section below and consider adding Toll Brothers, Ryland Group, and PulteGroup to your free and personalized watchlist so you can keep track of the latest news with each homebuilder.