Please ensure Javascript is enabled for purposes of website accessibility

This Growth Stock Is Probably Missing in Your Retirement Account

By Jason Hall - Feb 9, 2020 at 6:30AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Entry-level housing is a massive growth market, and this small homebuilder is already profiting from growing demand. There's a good chance you don't own it, and you probably should.

Over the past few years, Meritage Homes (MTH 4.67%) has gradually shifted its focus away from "move-up" homes, and made entry-level housing its biggest business. This was a bold step by the company, already a top-10 homebuilder at the time, to shift away from a business model that had proven successful and profitable. 

However, CEO Steve Hilton saw a huge opportunity on the horizon, and realized that it would take many years to fully realize the opportunity. The past decade saw homebuilders almost completely give up on building small, affordable homes for young people looking to make their first home purchase, leaving a massive underserved market with too little inventory to meet the needs of a growing population of first-time buyers. 

A roofer working on a new home.

The starter homes market has years of growth ahead of it. Image source: Getty Images.

So far it's paid off for the company and for investors, but the starter-home market remains undersupplied, and millions of young adults are looking to buy a home. That makes Meritage Homes, which is still relatively small considering the size of the U.S. housing market, an excellent growth stock to own in your retirement account. 

Making the starter-home pivot has paid off

It's paid off in spades for Meritage and its investors. Since the beginning of 2017 -- early in the company's transition to build primarily entry-level homes -- its shares have more than doubled. That's crushed a strong market, and also most other large homebuilders, measured by the SPDR S&P Homebuilder ETF (XHB 3.48%), over the same period. 

MTH Total Return Price Chart

MTH Total Return Price data by YCharts

The interesting thing about Meritage's growth so far is, its profits have skyrocketed over the past few years, even though revenue is only about 21% higher. That's because, despite selling for lower prices, entry-level housing has proven to be more profitable: 

MTH EPS Diluted (TTM) Chart

MTH EPS Diluted (TTM) data by YCharts

Gross margin has increased more than 6%, largely because starter homes can be build in a more efficient manner, with less customization. Its ability to increase gross margin in recent years is particularly impressive considering skilled labor shortages and volatile lumber prices.  

A trend Meritage can keep building on

Despite a great run that's seen its stock price double in three years, Meritage Homes still has plenty of room to grow. Housing starts have only recently returned to levels that are generally considered sustainable. 

US Housing Starts Chart

US Housing Starts data by YCharts

Moreover, the data above includes multi-family housing such as apartment buildings, not just single family properties. If we look at single-family home sales and inventory, you'll see that even with steady growth in recent years, we've only just now seen the market return to historical levels during healthy economic periods. The catch is, the country's population is significantly higher now:

US New Single Family Houses Sold Chart

US New Single Family Houses Sold data by YCharts

Moreover, the biggest generation in the U.S. is now millennials, many of whom delayed home purchases for a litany of reasons, including lack of economic opportunity or access to affordable housing. This is set to be a generational challenge, and Meritage is one of the few homebuilders that's made starter housing its primary focus. 

A great growth stock for your retirement account

Meritage Homes' growth is accelerating. The company saw home closing revenue 11% in the fourth quarter of 2019, but orders were up a strong 27% and order value was up 25%. Earnings per share increased 15% for the full year but leapt ahead 39% in the fourth quarter. At the same time, its operating expenses are also improving, with SG&A -- sales, general, & administrative -- expense falling as a percentage of sales in the year and quarter. This is another benefit of the shift to entry-level homes, helping drive down marketing and sales costs. 

Looking at valuation, Meritage shares trade for 11.4 times trailing earnings, a solid price for a homebuilder, particularly one with solid margins and lower-than-average debt leverage. Its PEG ratio -- a version of the P/E ratio that factors in growth expectations -- looks even better at 0.82. A PEG ratio below 1 is generally considered "cheap." 

Put it all together, and you have a well-run company that's made the pivot to exactly where new housing demand will be strongest over the next decade, trading for what appears to be a reasonable valuation. There will likely be plenty of ups-and-downs in the years to come (homebuilding is a cyclical business, after all -- but investors looking for growth in their retirement accounts should give Meritage Homes a close look. 

Jason Hall owns shares of Meritage Homes. The Motley Fool recommends Meritage Homes. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Meritage Homes Corporation Stock Quote
Meritage Homes Corporation
MTH
$87.18 (4.67%) $3.89
SPDR Series Trust - SPDR S&P Homebuilders ETF Stock Quote
SPDR Series Trust - SPDR S&P Homebuilders ETF
XHB
$64.92 (3.48%) $2.18

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
373%
 
S&P 500 Returns
122%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/10/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.