Nearly a decade after a housing-finance crisis sent the global economy into a tailspin, the American housing industry has shown several years of strength. And while housing in general is a very cyclical industry that can catch unwary investors off guard, there are a lot of reasons to think that 2017 could be a great year to invest in the sector.
There are four stocks at the top of my list that could make for great investments: homebuilders NVR Inc. (NYSE:NVR) and Meritage Homes Corp. (NYSE:MTH), decking disruptor Trex Company Inc. (NYSE:TREX), and home improvement specialty retailers Tile Shop Hldgs Inc. (NASDAQ:TTS) and Lumber Liquidators Holdings Inc. (NYSE:LL). Let's take a closer look at what could make these top housing stocks great buys for 2017 and beyond.
Strong demand for new homes makes these top homebuilders worth a look
Over the past 20 years, both NVR and Meritage Homes have made for incredible investments:
And both companies have been successful in large part by growing their scale and market share while also consistently delivering strong, steady margins and profits. That can be difficult to do in an industry like housing, where supply and demand can fluctuate, and every market can be different, as pricing, inventory, labor supply, and economic conditions all play a role in how much a new home costs to build and how much it can be sold for.
So what makes NVR and Meritage attractive today? A couple of things.
To start, both look relatively cheap, based on how the market has valued them over the past several years and as compared with their peers. Meritage Homes sells for a trailing price-to-earnings ratio of below 9 at recent prices, making it one of the cheapest homebuilders. It is also a good 15% or more cheaper than where it typically trades. In short, the market acts as though it doesn't have any faith in the company's ability to grow its earnings from here. NVR's trailing P/E is around 16.5, making it one of the more expensive homebuilders. But NVR's steady profits and cash flows, and an aggressive share buyback program that has returned enormous value to long-term investors, have "earned" that premium, which has historically been one of the higher in the segment.
Most importantly, shares are trading at a big discount to the company's historical earnings multiple.
Add it up, and both NVR and Meritage look like great homebuilder stocks to buy in 2017, particularly if the market continues to undervalue them.
These three companies are consolidating very fragmented markets
Trex is a manufacturer whereas Tile Shop and Lumber Liquidators are retailers, but all three are specialists in relatively fragmented segments of the home improvement industry, and they are all plays on the ability to disrupt that fragmentation and grow market share.
Among the three, Trex has proven to be the best investment in recent years, while Tile Shop and Lumber Liquidators have dealt with their share of struggles:
Trex has come to dominate the wood-alternative decking business, and now commands more than 40% of the market, but there's a bigger opportunity Trex is pursuing. Wood makes up over 85% of decking volume sold each year, while Trex accounts for only about 6% of annual board-feet. With this huge target in front of it, Trex has shifted its marketing focus to traditional wood. If past efforts to grow market share continue paying off, there's massive upside for the company and investors.
Tile Shop and Lumber Liquidators are slightly different opportunities, in that they're retailers that have dealt with their share of troubles. Tile Shop, which saw the departure of several key executives -- including the founder and former CEO -- following a scandal around insider ownership of a supplier, has turned the page under retailing veteran Chris Homeister. The company has steadily grown revenue and same-store sales over the past nearly two years, improving profits along the way and strengthening the balance sheet. Since Homeister took the CEO chair in 2015, Tile Shop's stock is up 132%. And with less than 125 total stores to date, the company's ability to expand in this very fragmented industry could drive huge returns.
Lumber Liquidators has the potential to be a turnaround play, but there's still a lot that must happen. The company's problems are directly related to its reputation with customers, which has been badly damaged since allegations -- largely disproven -- that the company was selling Chinese-made laminate flooring that significantly increased people's chance of developing cancer came out in early 2015.
The problem is that customers haven't started coming back at pre-allegation levels, and there are ongoing legal battles that continue to weigh on the company's expenses and reputation. But if the company is able to move past the litigation with minimal financial impact and put the issue firmly in the rearview mirror, the opportunity to expand its store base beyond the current 370 locations could make this stock a fantastic long-term investment. But until those concerns are dealt with, there's more risk with Lumber Liquidators than with any of the others, in terms of permanent losses for investors.
Be opportunistic, but think long-term
There are a lot of reasons to be bullish on housing stocks for 2017, including a relatively strong (and improving) economy with stable job and income growth, along with a general undersupply of homes in many markets. This should be good for NVR's and Meritage's ability to command pricing, and should underpin strong demand for home improvements in the bathroom, kitchen, flooring, and outdoor entertainment spaces, where Tile Shop, Trex, and Lumber Liquidators make a living.
But if housing is affected by unforeseen economic weakness, there's no promise that 2017 will turn out to be a good year for stocks like these. However, with the exception of Lumber Liquidators (due to its ongoing -- and expensive -- legal issues), NVR, Meritage, Tile Shop, and Trex are all built for long-term success. So even if 2017 doesn't turn out to be a good housing year and these stocks go lower, that could turn into a great opportunity to buy more for the next eventual upswing.