OUR TAKE
Homebuilders Defy Gravity

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By Tom Jacobs (TMF Tom9)
May 21, 2003

Homebuilder stocks are selling at historic highs, most with huge run-ups in the last two years as mortgage interest rates have collapsed to historic lows. The businesses sell houses faster than they can make them, and they are consolidating and gaining efficiencies like mad.

Yet when I took a few months to study homebuilders sometime ago -- in Homebuilders: Good Investments? and Nailing the Homebuilders -- I came up with nothing. I couldn't find the sustainable advantages, among other things, to project further gains from recent excellent business performance. 

So, what about their future? For this short Take, let's look at just one metric that may affect business -- and thus stock -- performance ahead: days sales in inventory (DSIs), also called inventory turns. (Check my column yesterday on this delightful, useful, and easy little investing number applied to Home Depot (NYSE: HD) and Lowe's (NYSE: LOW).)

Homebuilders maintain inventory of land on which to build homes and homes in varying states of completion. More is neither good nor bad by itself, first because the industry is rapidly consolidating, and second because for homebuilders, declining inventory might indicate that sales were growing so fast they couldn't keep up.

But if there were a slowdown, the first place it might show up would be a few quarters of increasing DSIs. So, let's look at year-over-year changes for the top 10 publicly traded builders by market capitalization for the last four quarters and four years. "MRQ" and "MRY" are most recent quarter and year, and Q2 and Y2 and so on are the preceding periods, because these companies' fiscal years and quarters vary. All tickers are New York Stock Exchange, except for NVR, which trades on the American Stock Exchange.

Which are doing better or worse in DSIs?

   DSI TRENDS FOR HOMEBUILDERS 
         DSI Change Vs. Year-Ago Quarter    
Builder         MRQ  Q2  Q3  Q4
Centex (CTX)      7  22  27  11   
Lennar (LEN)     17  -1  25  -5
Pulte (PHM)      12 -20 -29  34
D.R. Horton (DHI)-7   6  22  -3  
NVR (NVR)         2 -11   1  -7
KB Home (KBH)    -3   2 -18  15
Toll Bros. (TOL) 16  32  88  61
Ryland (RYL)     -7  16  29  40
Hovnanian (HOV)   8  -4   2  -6
MDC Holdings(MDC)10  35  24  36

         DSI Change Versus Prior Year
Builder         MRY  Y2  Y3  Y4
Centex           11   0  12  12     
Lennar           19 -30  31 -63
Pulte           -53 107 -10  -9
D.R. Horton       5  18   5 -14
NVR              -5   7  -7  -9
KB Home          14  -3  12 -30
Toll Brothers    63  34  -8  31
Ryland           31 -20 -13  20
Hovnanian         3 -53  -7  78
MDC Holdings     53 -17  34   6

Centex (NYSE: CTX), Toll Brothers (NYSE: TOL) (which should be Toll House, in my humble opinion), and MDC Holdings (NYSE: MDC) have the worst quarterly trends, with NVR (AMEX: NVR)Hovnanian (NYSE: HOV), and KB Home (NYSE: KBH) the best, and Ryland (NYSE: RYL) getting better. Lennar (NYSE: LEN), Pulte (NYSE: PHM), and D.R. Horton (NYSE: DHI) DSIs are too lumpy to draw conclusions from.  

Looking at annual trends, NVR and Hovnanian come out on top, with Toll Brothers looking the worst. Pulte performed a dramatic about-face in the most recent two years and MDC and Ryland went the other way.         

From this calculation alone -- and it's not the only one to use by a long shot -- NVR and Hovnanian appear to be managing their inventory most efficiently. Funny thing, but NVR came up the best in my research a few months ago until management's stock option grants waved a red flag.

And the most vulnerable to an economic downturn? Using DSIs, they appear to be Toll Brothers and MDC Holdings, and likely worse for Toll Brothers because it caters to the high-end market, usually the first and fastest to soften in a housing downturn.

What's your thinking on investing in homebuilders? Chat on our discussion boards (subscription or painless free trial required -- all well worth what you'll gain) for each builder, and our Homebuilding discussion board for the industry!

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