Why I'm Buying This Homebuilding Stock in 2014

My wife and I spent the past few months window shopping in some of the new communities under construction in our area. We'd never intended to actually buy a newly constructed home, but taking a look was just something to do until we really started searching for a new home in the spring. Window shopping soon turned to deeper research, which eventually became a signed contract to have our dream home built.

We were struck by what historically low interest rates enabled us to afford, especially when compared to what was on the existing home market. I was also thoroughly impressed to find that the average new home these days is typically 30% more energy efficient than an existing home. As I dug deeper I became more impressed with the potential offerings of homebuilders as more buyers considered these critical factors.

The one company that impressed me the most, both as a top builder and a top homebuilding stock, was PulteGroup (PHM -0.66%). Not only were its homes in my area of higher quality than those of other builders in the same price point, but the company's stock looks very appealing. That's why I'm not only buying a PulteGroup-built home in 2014, but I'll be buying its stock as well.

Slow recovery looks to be picking up speed
The data is pretty compelling that the housing market looks ripe for a rebound. There's a lot of pent-up demand because so many Americans have delayed buying a home. That has caused rising rents in many markets which, when combined with historically low interest rates, makes buying a home a good financial decision for many. In fact, this is why we have seen pretty big jump in home prices lately as the inventory overhang dried up. 

After years of underbuilding, the sector looks poised for a pretty good comeback in the year ahead. In fact, it's easy to make a case that other top homebuilders like D.R. Horton (DHI -0.21%) and KB Home (KB -1.02%) would make compelling buys in 2014 just based on a pickup in housing. However, there are two key differences that I believe really set PulteGroup apart and make it a much stronger investment than any of its peers.

Multi-brand strategy
PulteGroup is unique in that it has a multi-brand strategy that positions the company to benefit from all segments of the housing market. The company's Centex brand targets entry-level buyers and delivered 26% of its closings this year. Its Pulte Homes brand is focused on the move-up buyer group and represented 46% of closings in 2013. Finally, the Del Webb brand targets the active adult segment and was 28% of PulteGroup's closings this year.

While it is the only builder with distinct brands, PulteGroup is not the only builder targeting multiple buyer segments. Hovnanian Enterprises (HOV -3.18%), for example, has products designed for first-time buyers (33% of its product offering), move-up buyers (33%), active adult (13%) and luxury (21%). KB Home, on the other hand, focuses more than half of its attention on first-time buyers. 

That said, PulteGroup's strategy runs deeper than just separately branded communities. The company is focusing on building houses that consumers want through an emphasis on commonly managed plans that were created with customer input. PulteGroup built large-scale model plans in warehouses to get potential buyers to make suggestions. The company used this knowledge to design customer-approved plans focusing on giving homebuyers choice through a variety of upgrades and options. This strategy is working, as the company's gross margin has increased from 17% to 20.9% over the past year.

Financial strategy
PulteGroup is taking a much more conservative approach now with its capital. In 2013 the company paid off more than $450 million in debt, which cut its debt to capital ratio from 53% to 31%. The company is also using options to acquire land whenever possible in order to mitigate some of its risk. This has PulteGroup focused on value-enhancing growth, instead of growth at all costs.

Furthermore, instead of plowing all of its capital back into the business, the company is now returning a portion to investors. In July, PulteGroup declared its first dividend since the financial crisis hit. At the same time the company added $250 million to its share repurchase authorization, which at the time still had slightly more than $100 million left. The company believes that being more balanced with its capital allocation will enable it to deliver better returns over a full housing cycle.

Investor takeaway
Not only is PulteGroup strongly positioned to benefit from the rebound in the housing market, but its investors are as well. That's because its position of strength extends beyond just that rebound -- its multibrand strategy and financial discipline has the company well positioned for multiyear gains. That's why PulteGroup is the homebuilding stock I'm buying in 2014.