Homebuilder Stocks Getting Creaky

On Friday morning, A.G. Edwards did what many of us have been doing lately: talk down the housing sector. The firm issued sell ratings on Toll Brothers (NYSE: TOL  ) and Beazer Homes (NYSE: BZH  ) . It also downgraded Lennar (NYSE: LEN  ) and Pulte Homes (NYSE: PHM  ) to "hold" ratings.

To be fair, cynics have been calling for a burst of the housing bubble for years now, only to have arrived at their bearish stance unfashionably early. Even this week, the upbeat Commerce Department gave un upbeat announcement on new-home sales in March and Meritage Homes (NYSE: MTH  ) released a great quarterly report.

The cheering section will point to single-digit P/E ratios and healthy order backlogs. But the detractors will counter that interest rates keep rising, the high current prices aren't feasible, and the troubling trend of interest-only mortgages being taken out by desperate buyers continues.

Let's bring a little sanity to the sniping between the warring factions. First off, a slowdown in this sector is unavoidable. Building costs are rising, and current new-home prices will be challenged. With higher mortgage rates lowering the value of the financed buck, margins are likely to contract as developers find it more expensive to create a finished product that won't sell for as much as it used to.

It's not a pretty sight, but it also doesn't mean that real estate stocks will collapse. Bulls may be heartened to know that financial declines may already be priced in to the shares. For instance, analysts expect earnings at Lennar to dip to $8.87 a share next year after a $9.07-per-share showing this year. That may not sound rosy, but Lennar shares can be had for just 6.2 times next year's lower profits. That's certainly reasonable, even if there's an even deeper dip in fiscal 2008.

On the other hand, it's always possible that Wall Street analysts aren't being pessimistic enough. Fiscal 2007 estimates for DR Horton (NYSE: DHI  ) and Centex (NYSE: CTX  ) are higher than their 2006 targets, but reality may have something else in store, given how sentiment has been turning and may continue to turn. As an illustration, just three months ago, analysts figured that Lennar was going to earn $9.72 per share next year.

None of this spells a complete collapse of an industry that has fortified itself over the past few gravy years. However, at some point, this once red-hot growth sector is going to start attracting the value investors. It may not be now. A few more downgrades may do the trick. But in a few quarters, we may very well be at a point where new home prices may feel prohibitive yet developer stocks appear pretty darned cheap.

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Longtime Fool contributor Rick Munarriz has been living in the same place since 1999 -- but he did refinance twice when borrowing costs got dirt-cheap. He does not own shares in any of the companies mentioned in this story. T he Fool has a disclosure policy. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.