Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking two high-profile Wall Street picks and putting them under the microscope...
Investment banker Raymond James cut its ratings on homebuilders PulteGroup (PHM -2.26%) and D.R. Horton (DHI -1.78%) this morning, downgrading both stocks to market perform in twin notes covered on StreetInsider.com (subscription required). The reason for both downgrades was identical:
Raymond James last upgraded Pulte (to buy) in April, and upgraded D.R. Horton (to strong buy) in August, in anticipation of an event the analyst has called its "hope trade." The period for said "trade," however, has since expired, and experience has taught Raymond James that now's the time to "take a step back, monitor the spring selling data as it rolls in, and be more selective with valuation disparities in the group."
Here's what you need to know about that.
Image source: Getty Images.
What the heck is a "hope trade"?
Let's begin with the obvious question: What the heck is a "hope trade" anyway?
Raymond James explained this concept way back in 2013: "Based on our data documenting the performance of public homebuilders, we find the period running between mid-November and Super Bowl Sunday typically works best (generally November 15-January 31 on average) for this trading window. Most impressively, by our count, the homebuilding sector has outperformed the S&P 500 nine consecutive years during this calendar period, and 23 of the past 29 years."
So the "hope trade" is just market timing?
More or less, yeah -- Raymond James is trying to time the market here. Without a word on valuation, on regional demand for new homes, or even on interest rates, the analyst is stating quite plainly, for all the world to see, that its "hope trade" is a market-timing gambit -- and yet, it's worked for the analyst before.
Indeed, compared to the 79% success rate it mentioned when describing the "hope trade" concept back in 2013, Raymond James says its latest data now show that "historically speaking, the odds of generating meaningful stock outperformance among homebuilders ... during the "Hope Trade" window" is "80%+." In contrast, decisions to invest in homebuilder stocks like Pulte and D.R. Horton "from President's Day through Memorial Day" have no better than a "50/50" chance of outperforming the market.
And how has the "hope trade" worked out for Raymond James this year? Well, from Nov. 15, 2018 to Jan. 31, 2019, shares of D.R. Horton are up 14.5%, and Pulte stock is up 15.3%, while the S&P 500 is down 1% -- so I have to admit, this trade strategy has worked out pretty well!
You can't argue with success...or can you?
It's hard to argue with numbers like these -- albeit investors can certainly pose the chicken-and-egg question: Are housing stocks better performers from November to January for some good reason, or are investors, who've seen Raymond James's succeed with this "hope trade" before, buying homebuilder stocks in November in order to ride Raymond's coattails, and then dumping the stocks thereafter?
I can't answer that question -- but neither do I think that investors necessarily need to panic just because some arbitrary calendar window for when it's safe to own housing stocks has now closed.
Here's why:
Assume for the moment that Raymond James has in fact stumbled across a sure-fire way to successfully trade housing stocks during 2.5 months of the calendar year. Even if that's the case, investors still have to figure out what to do with these stocks during the remaining 9.5 months!
Do you buy housing stocks the rest of the year anyway? Do you short them? Do you...pretend they don't exist? Because if you take either of the last two routes, there's a big chance you'll be missing an even bigger opportunity than the one Raymond James highlights.
Check out the latest PulteGroup and D.R. Horton earnings call transcripts.
Valuation still matters
Consider: Raymond James is "stepping to the sidelines" on PulteGroup and D.R. Horton. But even after performing so admirably during the November to January period, PulteGroup shares still only cost about 7.6 times earnings, despite S&P Global Market Intelligence data showing that most analysts expect Pulte to grow its earnings at 13% annually over the next five years. D.R. Horton stock costs a bit more -- 9.8 times earnings. But it's expected to grow at 13.5%.
"Hope trade" or no, both these stocks still have a PEG ratio below 1.0.
Now, of the two, I personally prefer Pulte for its stronger free cash flow -- but that's just me. The fact remains that both these stocks remain cheap when valued on their earnings and growth, and just because Raymond James is sticking to a system that works for it, doesn't mean that investors with a longer-term investing horizon should feel compelled to sell out of PulteGroup or D.R. Horton shares.
