At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.
But in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and worst and sorriest, too.
And speaking of the best ...
Investment banker Lehman Brothers picked up a hammer and installed a new foundation under the crumbling homebuilder stocks yesterday morning. Initiating coverage on eight of the biggest, Lehman gave "overweight" (despite what it sounds like, in analytical circles, "overweight" is a compliment) ratings to DR Horton
The funny thing is, this sector has had so much bad news for so long, investors seem to be taking even "hold" and "sell" ratings as good news. Every single stock on the list, including the underweighted Hovnanian, was up yesterday! (Then again, so was the rest of the stock market.)
Stats that make you "Hmm"
Strange, though, that this across-the-board bullishness is based on brand-new coverage from a company lacking a track record in the homebuilding sector -- especially when you consider the analyst's record. According to CAPS, Lehman has a respectable 81.63 CAPS rating, but on absolute accuracy, the analyst is far from perfect. In fact, getting less than 49% of its guesses right, Lehman's a bit less accurate than a coin toss.
It gets worse. Before you rush out to buy these companies on Lehman's say-so, consider a few qualifiers included in the analyst's measured bullishness:
- "We do not believe that new home sales have yet reached a bottom."
- "We expect that [homebuilding] stocks could continue to be volatile over the next few months ... [before] trends ... improve by the back half of 2008."
- "We prefer companies with healthier and conservative balance sheets and proven return histories."
Thinking over a no-brainer
That last comment looks like a no-brainer at first glance, but it's actually the one that worries me most. You see, according to Lehman, the stocks it prefers are the ones with the best balance sheets -- lots of cash, falling debt. "Solid balance sheets are a necessary component to restoring some price stability to the market, as builders with fewer short term liquidity needs may be less likely to aggressively price land or inventory to generate cash."
That's the key point, to my mind. Even if we agree with Lehman that DR, Ryland, and Toll have the best balance sheets of the bunch (and I do agree on these three, although I'd point out that Lennar has as good a debt-to-equity ratio as Ryland does, and twice as much cash), there appears to be a hole in Lehman's logic. Strong as Lehman's top three are, weaker players are still going to feel pressure to "aggressively price land or inventory to generate cash." Such moves could pressure even stronger players like DR, Ryland, and Toll to drop prices to match.
I don't mean to pull the housing bulls' chain here. But there's a real risk that this industry is only as strong as its weakest link. Whether that link is "underweighted" Hovnanian, or the bullish analyst that gets more picks wrong than right, I'll leave you to judge.
Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's ranked No. 610 out of more than 84,000 players. The Fool has a disclosure policy.