Usually, finding a stock with a low P/E is an indication that investors don't expect a whole lot from the company in question. Yet even though Hovnanian (NYSE:HOV) missed estimates by only a small amount and lowered future guidance fairly modestly, the Street responded by taking down the shares of this homebuilder by about 7%.
Of course, homebuilders aren't your run-of-the-mill single-digit P/E stocks. There's that purported bubble to contend with. Everyone knows (or at least assumes to know) that this boom in construction of new housing has to end eventually, so a lot of investors and analysts sift through these earnings announcements for the merest hints of an "aha, I told you so" moment.
On the surface, there's not a lot to really hate about Hovnanian's quarterly report. Sales rose 24%, earnings climbed 32%, and homebuilding gross margins expanded. Deliveries of new homes increased by only about 6% in unit terms, but the value of those homes was about 23% higher.
Guidance, though, was the issue. Although company executives stuck to their guns and pointed out that they beat their own guidance, that's like pointing out the price of nutmeg in Batavia -- in other words, pretty irrelevant. True, it's not the company's fault if analysts get out in front of management's own projections, but that's the way the Wall Street world works. Speaking of that guidance, though, management said that sales prices on new homes were moderating, and the company lowered guidance for the next two years by about 4%-5% from prior mean estimates.
Pretty much everywhere you look, you see homebuilders trading at single-digit P/E multiples. "So," the novice investor asks, "how could I possibly lose if I buy stocks like Hovnanian, D.R.Horton (NYSE:DHI), Lennar (NYSE:LEN), or Centex (NYSE:CTX)?" Well, what happens if the bottom drops out of the earnings part of the P/E ratio? This is how, and why, cyclical stocks draw in the unwitting when the stocks approach their cyclical peaks -- the stocks look cheap until you realize the risk that earnings have peaked.
Have Hovnanian and its brethren peaked? Honestly, I don't know. What I do know is that the returns on equity we're seeing in the sector aren't sustainable -- unless we're all going to own two or three houses apiece. That suggests to me, then, that the risk/reward ratio in these stocks is tilted too much toward "risk" for my comfort.
For more homely Takes:
- Bad-Mouthing the Bubble
- Behind the Bubble Babble
- Don't Get Crushed by Your Home
- Home Sweet Homebuilder
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
