There is a fascinating article in today’s WSJ about a contentious valuation debate: Homebuilders judged by their book value.
What makes this intriguing is the combination of players in the space: The Homebuilders are loved/hated by an odd amalgam of value investors, technicians and short sellers.
Over the past year, I have been amazed that every bounce and short squeeze after a major drop has been declared proof of a bottom in Housing. With the biggest problem in the residential homebuilding sector being the enormous competition from the huge overhang of inventory for sale, I suspect the Homebuilders have a ways to go before they are attractive again.
Meanwhile, as this debate plays out, the ISE Homebuilders Index made a new multi-year low on the weekly charts:
ISE Homebuilders Index
Source: Stockcharts.com
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Here’s an excerpt from today’s Journal:
"A year ago, home-building companies looked like bargains. Looks can be deceiving. Many companies were trading near book value — a rough
estimation of what they would be worth in liquidation and typically a
green light to investors to buy the stocks. Turns out it was a faulty
signal, and one that is flashing to hopeful investors again.Value-seeking investors bought into the sector, and
the builders’ stocks surged toward the end of last year. But the
subprime debacle and a rising supply of unsold homes have sent
home-builder shares plummeting, erasing most of their gains.So, this time around, investors may be gun shy about
following the old rule of thumb of buying the home builders at book
value and selling after the shares have appreciated to at least twice
book value.The problem is that book value is more of a moving
target than a sure sign of a bargain. Book value is a company’s assets
minus its liabilities. Typically for builders, their largest asset is
land, which in some cases, amid falling home prices, is no longer worth
what they paid for it. That has forced builders to write down the land
on their books. Meantime, the builders are still paying down the debt
that they used to buy much of the land.
At the end of June, for instance, home builders were trading at 1.1 times book, with some large companies, such as Beazer Homes USA (BZH) and Hovnanian Enterprises (HOV), going as low a multiple as 0.6, or 60% of book value, according to Morgan Stanley."
Fascinating stuff . . .
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Can you judge a Homebuilder by its Cover?
chart courtesy of WSJ
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Source:
Rule of Thumb Hammered
Judging Home Builders By Book Value Can Sting As Write-Downs Mount
MICHAEL CORKERY and KAREN RICHARDSON
WSJ, July 9, 2007; Page C1
http://online.wsj.com/article/SB118394489186360570.html
It’s tough to like these stocks on a margin of safety basis when they’re at 1x book. We know these guys have had their moment in the sun as far as profits and asset value growth are concerned(at least until the next major housing cycle), so why would I be willing to pay 1x book value for a company with falling asset prices, falling equity (hello write-offs), declining profits and too much debt? Give me a call when these things get down to 0.6x book value and we have a few corporate bankruptcies.
I think the book referred to is “Grim Fairy Tales”.
Barry,
This is why many Wall Street analysts are worthless. They didn’t have the foresight, last year, to realize that the homebuilders problems were below the surface and valuing them based on the then current book value was mediocre analysis.
ALso, don’t forget the value of land options, which is quite possibly going to be ZERO, not just a haircut.
So absolutely, BV is a moving target. And the managements that have blown capital by buying in shares are ones to avoid. [NVR especially] They should be hoarding capital to buy distressed assets.
BTW, for my first 14 years in the biz, the homebuilders were a low volatility sleepy group that had little coverage and interest. My guess is that when they finally find a bottom, they will be sleepy again.
My valuations of homebuilders over the years relies primarily on assessing replacement book value. Ten years ago, book values were understated. Hence the good profits when their land invertory was monitized via building houses on them. Today book is overstated. Land inventory is a killer (bad) asset because it no longer appreciates, pays no dividends and is factored at some cost. Wake me in 3 to 5 years.
I wonder whether international public sentiment towards America has any correlation to house prices? If you had to pick a nation on the globe for a permanent home, what ya think? America?
Primary pros and cons in this decision: national debt & ability to provide for national needs, friendlyness & morality, fair business practices, ability to protect land & family, education & healthcare.
HOV is grossly overleveraged for the current environment. They said in their year end conference call that reduced build rates would lead to inventory liquidations so they expected to be cash flow positive by now. Hasn’t happened. They were still cash flow negative as of their last 10-Q.
Investors may be starting to discount potential bankruptcy risk.
A year ago there was a lot of chatter about the housing market bottoming because the homebuilders were rallying. Obviously, the market is always right. i hear that on Kudlow all the time.
I will ask the same question I have been asking for a while. I keep hearing people say they see signs of a bottom in real estate. What are they looking at?
The home-builders point up the problem of generic approaches to value investing; book value may be key in some sectors but not others. All the variables in the world won’t tell you what you need to know if the (usually relatively few) key variables are missed or insufficiently emphasized in analysis.
In the final post of Jeff Matthew’s excellent report on his experiences and observations at the latest Berkshire-Hathaway annual meeting (http://tinyurl.com/yu2y2m), Jeff writes of Buffet:
“…whether he’s talking about food companies or airlines or newspapers or oil companies, Buffet has clearly made it his business to identify the single most important variable for each business—and knowing those crucial variables, he can determine whether the values offered in the stock market at any given time are attractive, or not.
Without using a spreadsheet.”
It’s a great series of posts that begins at http://tinyurl.com/2sklxl
Back to the topic: Home-builders, and mortgage lenders too, have generally represented poor values* since 2005 and the primary risks to shorting them have been takeovers and carry cost associated with the time it took the market to work through the cheer-leading and bad data into the real world of their decline. Stated another way, there were enough chances at hitting a home run to more than make up for the whipsaws and squeezes.
*There are a few exceptions where the builder or lender was regionally focused and lucky enough to be in the right region but even these will likely slow down as various factors make loans more difficult to acquire, particularly among first-time buyers.
Book is as meaningless for HB’s as it is for CDO’s. Fair Value is everything. Stagnant measures do no justice in a dynamic environment.
The best thing about the chart is that it tell us that Homebuilder stocks can trade for 50% of written-down book value. Owners of the stocks should at least be ready for 80% of written-down book.
At the last bond shop that I worked for, we had a prohibition on buying homebuilder bonds. After the troubles of the early 90s, the rating agencies did not want insurers to have any significant holdings there. (We reversed that prohibition in 2002. In hindsight, that might not have been wise.)
“I wonder whether international public sentiment towards America has any correlation to house prices? If you had to pick a nation on the globe for a permanent home, what ya think? America?
– Greg0658”
I can tell you as a Brit with plenty savings, I would seriously consider moving to the US. Property from my perspective seems incredibly cheap, helped also by the fact the the pound is at 2.01 to the dollar, whilst prices for most goods and services seem about the same in both currencies, so basically everything in the US is HALF the price of the UK.
Half — including dollars . . .
unless you can buy the house with pounds that argument is essentially moot.
Ciao
MS
Obviously this BRITISH investor has Sterling.(LOL)
You will see more of this RATIONAL thinking. The US dollar has returned back to the levels it was at BEFORE THE CURRENCY CRISES. This is a function of other nation’s economies improving rather that just poor opinion of the U$D.
So he’s smart to use an appreciated currency to buy CHEAP assets here in the US. It’s fairly obvious.
Book value is a clearly a number driven by historical performance, and subject to change from fluctuations in market conditions. If a substantial portion of that number is market sensitive, then future changes in market value must be taken into account. If these adjustments cannot be clearly quantified, and a business downturn ensues, then I believe one should assume the worst.
This is the same sort of general mess some investors fell into with the telecom stocks, as I recall. Their book values beckoned, but the market for their services was in decline. So how much could they really be worth?
In my opinion, book values are only useful in assessing the value of stable capital-intensive (hard asset) companies, in stable businesses.
I think the articles and the post are unfairly critical of value investors. That a security purchased may go down in price in the short-term is par for the course for an investor, and certainly one of the value creed. The question is how were the long-term returns?
Let’s take Toll Bros (I arbitrarily picked one company). If I knew nothing more than the P/B of the homebuilder index (the chart above) but made it an investment policy to buy TOL when the P/B of the index first hit 1.0, and held on to the stock for 5 years, you would have slightly beaten the S&P 500 once, slightly underperformed once and solidly beaten the index once. The average returns from even this most simplistic approach would have been better than the stock market benchmark!
while TOLL is being mentioned let’s not forget insider buying and selling. that is not based on “book” values. see where the insiders were unloading massive amounts of shares in this sector….and be very careful about loading up for more than a trade before the guys who run these builders step up to the plate with their own money once more…they have a lot from all the shares they sold at the top.