Wednesday, June 01, 2011

With House Prices at Eight Year Low, Time to Buy Toll Brothers?

House prices hit an eight year low in March. Does this mean prices will rise from here and you should buy stock in housing giant, Toll Brothers (NYSE: TOL)?

The data on house prices suggests that we have not reached a bottom. As of March 2011, The S&P/Case-Shiller index of property values in 20 cities fell 3.6% to 138.16 from its March 2010 level, that was both the biggest 12 month decline since November 2009 and the lowest level since March 2003.

And those prices could keep falling. Foreclosures create a supply overhang that could push prices lower and keeping builders away. In March 2011, about 1.8 million houses were at least 90 days delinquent, in foreclosure or bank-owned. This so-called “shadow inventory” is estimated at 3.87 million previously owned properties on the market at the end of April.

Not only is there too much supply, but many factors are crimping demand. Among these are 9% unemployment and tighter lending conditions. Paul Dales, a senior U.S. economist at Capital Economics Ltd. in Toronto told Bloomberg, “I wouldn’t be surprised to see prices continue to fall this year and maybe into next year.”

This housing disaster is not much of a surprise. In March 2007, I predicted a depression was on the way -- 16 months before the collapse of Lehman Brothers. How so? Income inequality hit a record not seen since 1928, the year before the Great Depression and middle class consumers were borrowing a record $2.4 trillion trying to keep up. $1.3 trillion worth of subprime mortgages had been issued and 47% of those were so-called liar loans. To those who claimed that nobody saw this coming, I count myself among the nobodies.

The question for investors is whether all this gloomy news on housing is already factored into the prices of housing stocks. If so, perhaps this is a time to buy them.

Let's look at Toll Brothers. This $1.5 billion (last 12 months sales) housing construction company earned a $60 million net profit. It builds single-family detached and attached houses in so-called "luxury residential communities." It caters to a variety of customer segments including move-up, empty-nester, active-adult, age-qualified and second-home buyers in 19 states of the United States.

In its second quarter of 2011, its financial results were not as bad as expected. For the quarter ending April 2011, its loss narrowed to $20.8 million, or 12 cents a share, from $40.4 million, or 24 cents a share, a year earlier. Revenue rose about 3% to $319.7 million. And Toll Brothers raised by 4.5% to 2,300 its estimate of the low end of the range of the number of houses it would deliver in fiscal 2011 while keeping the high end at 2,800, according to Reuters.

Is now the time to add Toll Brothers to your portfolio? To think about that, we can look at its price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.

Based on its PEG of 0.04, this stock is a screaming buy. It sports a P/E of 59 but its earnings are forecast to grow 1,430% to $0.45 in 2012. Unfortunately, Toll Brothers has been missing its earnings forecasts substantially -- by an average of about 23% in the last two quarters. But that amounted to a loss that was about two cents a share worse than forecast. If Toll Brothers missed its 2012 forecast by that much, its PEG would still be very low.

With Toll Brothers stock down 57% from its June 2005 high of $51 and up about 21% in the last six months, it looks to me like Toll Brothers may have more upside than downside ahead. 


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