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3 Stocks to Watch in Residential Construction

By Reuben Gregg Brewer - Sep 10, 2015 at 10:35AM

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Residential construction is a surprisingly fragmented market, but a few of the companies worth watching are large players

When it comes to residential construction, the barriers to entry aren't too steep. Just about anyone can manage to build a home or two. But to build homes on a large scale is something completely different. That's where giants such as D.R. Horton, (DHI 5.13%), Lennar Corporation (LEN 5.20%), and PulteGroup, (PHM 4.98%) come in, and why these giants are three stocks to watch in residential construction.

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PulteGroup has a market cap of over $6.5 billion, making it one of the largest homebuilders in the United States. It has operations in 26 states, with a focus on roughly 50 markets. Its operations are fairly well diversified by region, spanning the Northeast, Southeast, central states, and western states. That provides a fair amount of diversification to regional market trends, something you'll want to watch in the sector.

The company builds homes under the Pulte Homes, Del Webb, and Centex nameplates and constructs everything from single-family homes to townhouses and condominiums. It also offers multiple price points, including entry-level and move-up, or "second," homes.

As you might expect, the housing market is a key determinant of PulteGroup's success. For example, the 2007-to-2009 housing-led recession was a brutal period for the homebuilder. In fact, the red ink started in 2007 and didn't end until the bottom line was back in the black in 2012. That's a lot of pain and has led the company to take a more conservative stance with regard to land purchases and speculative building. That may not be such a bad thing, however, because homebuilding is an often volatile sector.

Home base. Source: Coolcaesar, via Wikimedia Commons.

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Lennar Corporation, with a market cap of around $10 billion, is up next. This residential construction expert has operations in 17 states and 40 markets. It, too, has fairly broad diversification across the country. Building homes accounts for about 90% of the company's top line.

The rest of its business comes from a mortgage line, which helps support its home sales and is a service most large homebuilders also offer, and a multi-family rental business. That's a bit different from its peers, and while small, it has the potential to become a more meaningful contributor over time. For example, if Lennar chooses to retain ownership of apartment properties, rent rolls could help offset some of the cyclical nature of the homebuilding segment. This, then, is a small business worth watching.

That said, homebuilding is still the core and the sector to keep an eye on. For example, you'll want to watch both the company's deliveries of new homes and its backlog of homes yet to be built. The former tells you what's going on now, and the latter can help you figure out how bright the future may be.

D.R. Horton, with a market cap of nearly $11 billion, is truly one of the largest builders in the land. It builds homes across the cost spectrum, from starter to luxury, with exposure to 27 states and nearly 80 individual markets. Its nameplates include D.R. Horton, Express Homes, and Emerald Homes.

As with all the builders, you'll want to watch the company's deliveries and backlog. You'll also need to keep an eye on the cyclical homebuilding market. And, like its peers, you'll want to watch costs. After suffering along with its peers during the 2007-to-2009 industry downturn, Horton has been a little more conservative with its business.

That's fine, but part of that is pulling back on land purchases, like PulteGroup, which means that both homebuilders could wind up facing increased costs for land if the market heats up. Labor costs and the cost of such things as lumber are also issues to watch on the cost side for Horton and its competitors that transcend the issue of land.

Nearly a home. Source: U.S. Navy photo by Mass Communication Specialist Seaman Apprentice Ryan Steinhour, via Wikimedia Commons.

Interestingly, however, about half of D.R. Horton's business comes from the lower end of the home market. So while being more conservative is a potential drag on performance during a housing upturn, hefty exposure to what are basically starter homes could be a notable tailwind. In an upturn, sales of smaller homes are likely to heat up faster than the more expensive ones, which are bought by people less constrained by the economy's ups and downs.

Plenty of options
If you're watching the residential construction market, you have plenty of options. Horton, Lennar, and Pulte are just three of the largest players, though each has an interesting story to tell and could easily find a place in most investors' portfolios. You'll just want to make sure you understand some of the key industry drivers, such as the housing cycle, costs, and market segments, before you step into the space. And on an individual basis, you'll want to get an idea of things that differentiate one company from another, like Lennar's apartment foray.

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Stocks Mentioned

PulteGroup, Inc. Stock Quote
PulteGroup, Inc.
$42.97 (4.98%) $2.04
Lennar Corporation Stock Quote
Lennar Corporation
$75.73 (5.20%) $3.74
D.R. Horton, Inc. Stock Quote
D.R. Horton, Inc.
$69.00 (5.13%) $3.37

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

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