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3 Homebuilders to Evict From Your Portfolio

A stronger home market may be coming, but these shares have gotten ahead of any rebound

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Looking for a good read on the state of the long beaten-down homebuilding sector? Pay attention to DR Horton’s (NYSE:DHI) earnings report for the quarter ending Sept. 30, due out on Friday. With the economy on the precipice of a recession, but still growing for now, DR Horton’s numbers will be less important than its future guidance.

Investors in homebuilding stocks have been acting bullish on stocks in the group without confirmation of a true turnaround based on the numbers. It’s all hope that at some point homebuilding will be profitable, and consistently so.

After many false starts, I think the odds of a true rebound in the industry are more likely than not. Strong earnings reports from homebuilders will confirm that something good may be on the horizon. Does that mean you should buy their stocks today?

Actually, I believe the opposite. Valuing homebuilding stocks is simply a matter of looking at book value. Here’s why: Homebuilders aren’t like, say, tech stocks. Investors shouldn’t expect homebuilders to post huge amounts of growth. Therefore, paying a multiple of earnings as you do with growth stocks doesn’t apply. The discipline in homebuilding requires you to buy at book value or less. To the extent shares trade for less than book value, homebuilders should be bought aggressively. Historically, this has been a profitable strategy.

But after a huge rally in October, many homebuilding stocks are trading well above book value. So, now may be a good time to take some money off the table in advance of earnings reports.

While I am optimistic on homebuilding in the long run, stocks are a bit too far out in front for my taste. Home sales in September grew at a weak pace, and sentiment among homebuilding companies fell in during that month.

Specifically, homebuilding is weighed down by foreclosures that continue to mount. Another troubling sign is the third-quarter increase in mortgage late payments. Throw in the volatility caused by Europe’s debt crisis, and there are plenty of reasons to be nervous in the short run.

None of this should be a surprise to anyone who has followed the boom and bust in homebuilding. The industry experienced a once-in-a-lifetime event. To recover will simply take time. Investors, however, are impatient and ever optimistic. The recent run-up in homebuilding stocks is another in a long line of hopeful rallies.

This one has gone about as far as it can. I would be a seller of homebuilder stocks today. Here are three to consider jettisoning from your portfolio:

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