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Throw This Stock Away

By Rick Munarriz - Updated Apr 5, 2017 at 8:03PM

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If you find something better, replace it.

The past few weeks have been good to investors in the homebuilding sector.

Did you ever think you'd hear that again? The government is taking bold steps to stabilize home prices by cleaning up the mortgage-market mess and lowering borrowing costs. When you add those incentives to an out-of-favor niche long slammed by the market, a bounce in stock prices should be no surprise.

However, there's a big difference between an artificial bump and an actual recovery. I'm very cynical about some of the big movers in what is still a very troubled industry, so I'm going to diss one stock (and suggest three replacements for your portfolio).

Who gets tossed out this week? Come on down, Lennar (NYSE:LEN).

You can't go home again
Since bottoming out just a few trading sessions ago, shares of Lennar have nearly tripled. Before you try to wrap your head around that kind of short-term gain, let's shed a little more color here. Two weeks ago, UBS got the ball rolling, upgrading the stock with a buy rating, despite lowering its near-term price per share target from $12 to $8.

Pull up a fresh quote on Lennar, and you'll see that it has already surpassed that target. Kudos to UBS for the great call. The opportunistic traders thank you. Now what will Lennar do for an encore?

After six consecutive quarterly losses and a brutal string of asset markdowns, the company is still at least a couple of years away from a return to profitability. Even if residential developers bottom out in the next year or two, the stocks won't truly recover until homebuyers flock back to cookie-cutter developments out in the suburbs.

Do you really see that happening? We have a glut of existing homes on the market; do we really need more? Incentives to encourage home purchases, like lower mortgage rates, tax credits, and looser credit, may help the industry as a whole, but it will be awhile before demand catches up to the supply of homes already standing.

Homes were like tulip bulbs, Beanie Babies, and Pokemon cards before the floor fell out of the market. Property flippers were buying several homes at a time. Lousy credit risks were buying homes they could not conceivably afford. I don't need to bore you with the obvious history lesson.

My point is only that developers like Lennar will have a hard time defying the urbanization movement by erecting costly projects in the outskirts. Sure, Lennar has the occasional project that makes sense, like the Candlestick Point redevelopment project in San Francisco, in cahoots with the 49ers. But it will take many years before we need to build new homes en masse, when so many better-located existing homes sit vacant.

When the economy bounces back -- and it will -- homebuilders will be the last to benefit. Now is certainly not the time to buy Lennar, even if consolidation will help rid the niche of its weakest developers.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

Homex (NYSE:HXM)
I wouldn't touch stateside developers with a 10-foot utility pole, but Mexico is a different story. Homex is thriving, particularly in the low-cost housing market. Homex recently projected 8% to 10% top-line growth in 2009. Analysts have been slashing estimates on the company lately, but it's still squarely profitable, and it's now fetching just five times next year's projected profitability.

That low multiple is the key. Profitable builders, like Homex in Mexico and Gafisa (NYSE:GFA) in Brazil, may take their global recessionary lumps, but they're already in a much better place than their stateside counterparts.

Lowe's (NYSE:LOW)
If actual homebuilders will be the last to feel the effects of a housing-market recovery, who will be the first? The battered home-improvement superstore concepts, like Lowe's and Home Depot (NYSE:HD), are prime candidates to bounce back, as lower rates spur mortgage refinancing to fund home-improvement projects.

Since creditors will make sure that potential homebuyers only qualify for digs they can afford, many will have to settle for less space than they're used to. Again, that will be a boon for Lowe's and Home Depot, as homeowners look to maximize closet space or expand their homes.  

Any whiff of beefed-up tax credits for home ownership or subsidized 4.5% mortgage rates will send folks scurrying for the countless used homes sitting empty. That's great news for Move's site. Even the dour economy could help; layoffs may spur folks to move around the country in pursuit of new jobs, which should naturally benefit Move's namesake residential moving services directory.

The company has endured a few quarters in the red, but analysts see a return to profitability next year. A related play is parent Tree (NASDAQ:TREE). It's further away from profitability, but it's trading for less than the cash on its balance sheet.

Sorry, Lennar. I know you've come a long way back in such a short time, but your capital appreciation is unfashionably early, while your fundamentals haven't even bothered to RSVP to the Turnaround Ball.

Other headlines from the weekly trash bin:

Do you like my substitutions? Would you rather stick it out with the tossed company? Are there other stocks I should look at in future editions of this column? Let me have it in the comment box below.

The Home Depot is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz hates hating on hometown companies, but he doesn't buy into the Lennar run-up. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

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Stocks Mentioned

Lennar Corporation Stock Quote
Lennar Corporation
$88.27 (0.58%) $0.51
The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
$314.89 (1.35%) $4.20
Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
$206.47 (2.12%) $4.29

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

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