But this change has been met with its share of skepticism. While housing starts increased by 15% in September, many observers doubted the actual volume of sales in housing, pointing to the 1.7% sales decline that month. Data from the National Association of Realtors, however, shows that sales have been improving in the long term, growing by 11% since last year. And more recently existing home sales increased by 2.1% since September.
“The super cyclical housing market has turned and a strong recovery in new-home sales is ahead,” wrote Joshua Pollard, a Goldman Sachs housing analyst, in a recent report. “We could see 50% growth in new home sales without additional job growth.”
There are reasons to believe that the decline in September was due to historically low inventory. But low inventory can play out positively in the long run. As home builders increase that inventory, they are set to gain pricing power, increasing their operating margins.
On top of that, research from the Mortgage Bankers Association shows that mortgage volume for retail has grown 163% since the beginning of 2011. And with the mortgage volume confirming the Housing Market Index, it seems buyers and sellers agree that this market will grow.
But despite a strong uptrend among home builders, one prudent way to profit from the growth is to diversify among stocks within the housing sector in related businesses, as Warren Buffett did.
Several companies that operate more efficiently and are undervalued are Lennar, D.H. Horton, Home Depot, Pier One and Sherwin Williams.
DHI & LEN
With housing construction and housing inventory near historical lows, D.R. Horton and Lennar both outperformed their peers, rising at 54.64% and 95.10% on the year, respectively, against a market return of 10.34%.
In a recent research report, Credit-Suisse analyst Dan Oppenheim emphasized that increased demand would seemingly help all homebuilders. But this demand will increase working capital needs and will likely reduce cash on the balance sheet, which reduces the ability to acquire more land. Fundamentally, DHI and LEN are the two of the largest home builders and have strong balance sheets, allowing them flexibility in debt financing—critical to acquiring new properties. With credit markets remaining tight for small companies, diminutive competitors don’t have the same flexibility in financing.
Both DHI and LEN have great operating margins at 4.71% and 4.85%, compared to a peers’ average of 0.46%, which positions their stocks to take advantage of high growth in revenue. And both companies are undervalued in terms of P/E valuation, with DHI at 25.35 and LEN at 39.58 compared to an industry average of 46.19 according to Bloomberg.
HD
Home Depot shows great promise with a 51.50% return so far this year. Given that housing segment has yet fully recover, people will continue to improve their homes which leads to increased sales for HD. On top of that, areas hit by Hurricane Sandy will help drive up sales.
But what helps HD stand out from competition is the cost leadership that HD had managed to retain. Since 2006, HD increased its operating margin through efforts such as developing its supply chain management, which reduced cost of transportation and inventory, and developing a formal distribution channel which increased bargaining power over suppliers. HD operates three times more efficiently than its peers’ average, at the rate of 10.08% of revenue.
PIR
Pier One Imports competes with the likes of IKEA and Target in the home furnishing business, and its sales continue to increase despite hard times for retailers. And this resulted in a 41.92% return year to date in its stock price. PIR managed to do so because it offers high ended and unique products to the customers who have a higher willingness to pay for such products. As a result, PIR has a wide operating margin at 10.4%.
That might increase further as PIR becomes more of an online retailer, thus reducing costs. In a recent research report, Credit Suisse analyst Gary Balter notes that PIR’s e-commerce business combined with store upgrades will increasingly important growth contributors over time.
SHW
Sherwin Williams has been a very popular stock lately, growing 77.00% this year to date. Sherwin Williams sells premium paint that is priced higher than competitors such as Benjamin Moore, Dupont and BASF. And Sherwin Williams have huge potential as paint sale will increase when housing starts continue to increase.
And while Sherwin-William’s P/E is higher than the peers’ average, it stands to benefit from lower cost. Titanium dioxide, which is a key ingredient in Sherwin Williams’ paint, fell by 5% in the third quarter this year as Jeff Zekauskas, a J.P Morgan analyst wrote. Titanium dioxide is set to fall another 5% in the fourth quarter. So despite a higher P/E for SHW, this company operates twice more efficiently than competitors’ average, so SHW is well positioned to take advantage of top line growth as housing picks up.
| Ticker | Operating Margins | Industry OM Avg. | P/E | Industry P/E Avg. |
| DHI | 4.71 |
0.46 |
25.36 |
46.19 |
| LEN | 4.85 |
0.46 |
39.58 |
46.19 |
| HD | 10.08 |
3.43 |
21.84 |
23.93 |
| PIR | 10.40 |
3.43 |
17.79 |
18.87 |
| SHW | 9.63 |
4.82 |
25.04 |
15.40 |
(credits to gurufocus.com and Bloomberg)
