The house rules are simple in this weekly column.
I bash a stock that I think is heading lower. I offset the sting by recommending three stocks as portfolio replacements.
Who gets tossed out this week? Come on down, Toll Brothers (NYSE:TOL).
A strong foundation isn't enough
There was nothing wrong with this morning's report out of the leading high-end homebuilder.
Revenue soared a better-than-expected 48% to $632.8 million, as Toll delivered 1,088 homes -- 44% ahead of last year's fiscal fourth quarter. It's encouraging to see revenue growing higher than deliveries, since that means that prices are moving higher.
It gets better.
Cancellation rates have fallen from 7.9% to 4.6%. As real estate prices firm up there's no point in walking away from a contract. The backlog of homes that Toll has yet to deliver is 70% ahead of where it was a year ago in terms of dollars and 54% in terms of units. Toll signed contracts for 4.86 units per community during the quarter, and that's Toll's highest fourth-quarter showing since 2005.
In other words, the near-term prospects appear bright.
Investors know it. The stock hit a five-year high a few months ago.
What if this is as good as it gets for Toll?
The whole "fiscal cliff" fear is real, and it isn't likely to end favorably for Toll's potential customers. See, Toll's properties aren't cheap. The average home delivered this past quarter sold for $582,000, and Toll is targeting an average of $595,000-$630,000 in its new fiscal year.
There seems to be no way around the reality that tax rates will inch higher for high earners come January. There's also the possibility that the mortgage interest deduction will go away, at least for couples pulling in more than $250,000 a year.
What happens when Toll's customers have less money to spend on primary or secondary homes?
You know the answer. Even before we get to the inevitable uptick in interest rates that will sting all homebuilders, Toll is susceptible as class warfare rears its ugly head in a few weeks.
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.
- Lumber Liquidators (NYSE:LL): New residential construction may be in for a hard landing, but it may also mean that folks just stay where they are now and spruce up their current digs instead. Lumber Liquidators is the country's leading hardwood flooring specialist. Nothing classes up a place like hardwood, and Lumber Liquidators offers up the planks at discounted prices. It's on a roll these days. Sales and earnings soared 19% and 91%, respectively, in its latest quarter. Investors have noticed. The stock has more than tripled this year! The bottom line is that the stock may not be exactly cheap right now, but its fundamentals have a better chance of holding up come 2013's pain than Toll does at this point.
- Trex (NYSE:TREX): Sticking to the Lumber Liquidators theme of home improvement outperforming new home construction in the coming years, Trex is another name to consider as the country's leading provider of wood-alternative decking. Building outdoor decks requires weather-resistant materials, and Trex is the premium brand in this niche. It's not growing as quickly as Lumber Liquidators. Revenue is only climbing at a 15% clip through the first nine months of the year. However, just like Lumber Liquidators, Trex has blown past Wall Street's profit targets in each of this year's first three quarters. Instead of buying Home Depot (NYSE:HD) as a reasonable play on home improvement, investors can do better by singling out the specialties that truly add value to a home. A patio deck outside as well as hardwood floors inside are two smart trends to follow.
- Zillow (NASDAQ:ZG): Even as the market lost interest in residential real estate, Zillow was growing. Revenue soared 67% in its latest quarter, fueled primarily by the growing number of real estate professionals that are becoming premium Zillow members for enhanced access to Zillow's growing base of home seekers. Yes, Zillow's magnetic. It attracted 37 million unique monthly visitors to its mobile apps and namesake website in the month of July alone. A secondary offering and stiff valuation have tripped up Zillow lately, but it's positioned well to capitalize when it comes to home ownership and the rental decisions that folks will continue to make.
Longtime Fool contributor Rick Aristotle Munarriz has no positions in the stocks mentioned above. The Motley Fool owns shares of Lumber Liquidators, Trex, and Zillow. Motley Fool newsletter services recommend The Home Depot, Lumber Liquidators, Trex, and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.