What happened
Shares of homebuilder Toll Brothers (TOL -0.84%) rose a dramatic 34% in May according to data from S&P Global Market Intelligence. Although the shares were still lower by 18% through the first five months of 2020, compared to a loss of about 5% for the S&P 500 Index, they are well off the lows they reached in March. At that point, the stock had lost more than half of its value as investors feared COVID-19 would lead to massive changes in home buying trends. When that didn't come to pass, investors quickly got a lot more positive about Toll Brothers' stock.
So what
The interesting thing here is that Toll Brothers doesn't report earnings on a calendar year basis. Its fiscal year ends in October, which means its fiscal second quarter includes April. April was basically the first month to feel the full brunt of the government's effort to contain the spread of the coronavirus by forcing non-essential businesses to shut and asking people to practice social distancing. So, when Toll Brothers reported earnings in May, the results provided a deeper look at just how bad things had gotten.
Image source: Getty Images.
Only they really hadn't gotten all that bad, which helps explain the price gains in the stock. For example, while the company did have to deal with a difficult selling environment, it still signed contracts for nearly 1,900 units in the quarter. And while the backlog has fallen, Toll Brothers still has a roughly $5.5 billion backlog of work to complete.
Notably, once government restrictions eased, deposit activity increased 13% year over year, showing that there was notable pent-up demand for the company's homes. According to Toll Brothers, deposits generally precede a contract by a few weeks. And just as important, the company's conversion rate, turning deposits into contracts, hasn't changed. In other words, COVID-19 was a disruption, but at this point, it appears as though it was a temporary one.
Now what
Toll Brothers' fiscal second-quarter earnings report wasn't all positive, noting that earnings were down by about a third year over year. However, there was clearly enough positive news in the release that investors think the future will be far less bleak than feared.
Still, long-term investors should tread lightly, here, since the efforts to contain COVID-19 are likely to send the U.S. economy into a recession. If that does happen, Toll Brothers will have a whole different headwind to deal with.
