What happened
Shares of homebuilders D.R. Horton (DHI 2.08%), PulteGroup (PHM 2.45%), and Meritage Homes (MTH 2.26%) rose by double-digit percentages in January. The residential-housing companies rode a trend of improving housing-sector data throughout the month, and wrapped up by reporting positive earnings numbers. When all was said and done, shares of Horton were up 12.2%, with Pulte up 15.1% and Meritage soaring 16.1% for the month.
All three, though, showed above-average performance for the sector. The S&P 1500 Homebuilding Sub-Industry Index was up 11.6% for the month, and some homebuilders, including Beazer Homes USA, actually lost ground in January.
Top homebuilders handily outperformed the stock market in January. Image source: Getty Images.
So what
A rising tide lifts all boats, and the rising tide in the housing sector lifted most homebuilders, too. Housing data released during the month was encouraging, and the stock market rewarded most homebuilders with steadily increasing share prices.
Perhaps the biggest housing news was a surge in housing starts in December. According to the U.S. Department of Housing and Urban Development (HUD) and the U.S. Department of Commerce, housing starts hit their highest level in 13 years in December after jumping 16.9% over the prior month to 1.608 million. Adding to the enthusiasm, November's data was revised upward by 10,000 units to 1.375 million. Better still, December's starts were up 40.8% over the prior year, thanks in part to unusually warm weather.
Mortgage rates also fell throughout the month. On December 26, the last reporting date of 2019, Freddie Mac reported that the standard 30-year fixed-mortgage rate was 3.74%. By January 9, it had fallen to 3.64%, and on January 30, it was just 3.51%. Lower mortgage rates often correlate with increased interest in home purchasing, so this cheered the market, as well.
What else
The month was capped off with a slew of Q4 2019 earnings from homebuilders, but luckily, D.R. Horton was the first major homebuilder to report, on January 27. I say "luckily" because Horton -- the second-largest homebuilder in the U.S. by units sold -- posted an impressive year-over-year performance and an improved 2020 outlook, which encouraged the market to bid up shares across the sector for the biggest overall one-day gains of the month.
Horton, which also owns the Express Homes, Emerald Homes, and Freedom Homes brands reported a 14.3% jump in revenue over the prior-year quarter, which it was able to translate into a 53% year-over-year (YOY) gain in earnings per diluted share. This was due in part to Horton's geographic mix of homes, with more than 60% of the company's home inventory in the fast-growing South. According to the U.S. Department of Housing and Urban Development (HUD) data, home sales in the South are growing much faster than any other region of the country.
Meritage Homes is even more southern-focused than Horton. Of its nine state markets, six -- Florida, Georgia, North and South Carolina, Tennessee, and Texas -- are located in the fast-growing South, with the other three -- Arizona, California, and Colorado -- in the West, where growth may be slower but prices tend to be higher. Like Horton, Meritage saw double-digit YOY revenue growth, at 11%, and much higher YOY growth (39%) in earnings per diluted share.
PulteGroup also has a substantial presence in the South, but when it reported earnings on January 28, it hadn't done anywhere near as well as Horton. Revenue and net income were both flat on a YOY basis, and adjusted earnings per share (EPS) only grew by 2.7% over Q4 2018. However, the market shrugged off this comparative weakness, in part due to the company's 33.4% growth in new orders and in part due to an intriguing new acquisition by the company.
Pulte announced it had purchased Jacksonville-based ICG, an offsite builder that primarily does pre-assembly of wooden wall frames and roof trusses, which are then transported to construction sites ready to be installed as part of the frame. This saves valuable onsite time and often reduces overall costs, especially labor costs.
Pulte, which is aggressively expanding its offerings in the entry-level home market, is excited by the prospect of potentially adding additional offsite construction methods to improve margins. For example, ICG currently offers pre-assembled floor systems, and Pulte is exploring the possibility of developing offsite-built walls with preinstalled windows, electrical, and plumbing.
Now what
Since the end of the month, the shares of each of these three companies -- and of residential homebuilding stocks, in general -- have continued to advance, as more companies report the same basic pattern of Q4 earnings: higher revenue coupled with much higher earnings and an improved outlook for 2020. That should translate into continued outperformance for D.R. Horton, PulteGroup, and Meritage Homes -- assuming nothing happens to disrupt current economic trends.
Investors should remember, though, that the housing market is cyclical and is currently more than eight years into an uptrend. If economic or housing data suddenly turns south, it's likely these stocks will take an immediate hit. And if we enter a full-blown recession, share prices are all but guaranteed to tumble.
However, if you're bullish that the sunny U.S. housing market and booming economy have several more years of growth ahead, these three companies look like good values right now. Even with their recent growth, all three are trading near the lower ends of their historic valuation ranges, with price-to-earnings ratios of between 11.3 (Meritage) and 13.1 (Horton).
If you're less convinced that the trend will last, you may want to keep an eye on these stocks to see if a better buying opportunity presents itself.
