by John Jagerson and Wade Hansen | November 8, 2012 2:21 pm
Recommendation: Buy HOV on a dip
Option alternative: Buy to open the May 2013 $5 calls
All week, investors have blown the roof off Hovnanian (NYSE:HOV). The stock has gained at least 3.5% every trading day since Oct. 31, and it’s gained more than 60% in two months. Even Hurricane Sandy couldn’t slow down the stock’s momentum — and continued strength in the housing sector could bring even more upside for this hot stock.
The Case-Shiller home-price index showed that home sales remained brisk over the summer, and investors have been bullish on the sector despite the recent broad-market selloff.
But they started getting nervous once Hurricane Sandy blew ashore. Many homebuilders experienced a mild drop in share prices. Not Hovnanian.
HOV has continued to rise since Q3, its best quarter in over six years, in part fueled by a well-timed statement from the company last Friday when the rest of the market was closing the week on a down note. This report announcing that the storm would not affect the outcome of its next quarter’s earnings was a lone bright spot among news items that day, and investors surged into HOV.
The stock made a breakout from previous resistance that day and then quickly went above $5 a share. That opened up the possibility that the stock could be picked up by more institutional investors, many of which have rules against buying any stock under $5.
HOV hasn’t been priced that high since 2010, and it’s been more than four years since its price remained above that level for more than two months. The last time the company had two consecutive quarters of positive earnings, the stock was priced at $25 a share.
Click to EnlargeThree facts point to a continued rally in the homebuilding sector:
Lumber Liquidators (NYSE:LL) and Louisiana Pacific (NYSE:LPX) could both be used as a proxy for lumber prices, and both are showing an upward trend YTD. The demand for construction materials will continue to drive prices higher. The price trend for Home Depot (NYSE:HD) and Lowe’s Companies (NYSE:LOW) reveals that home improvement stores are also showing a continued uptrend.
Perhaps the strongest evidence for continued bullishness comes from the fact that these stocks rose over the past month when the S&P 500 trended downward. There’s demand for construction materials even when investors are looking for safe investments.
Click to EnlargeHOV narrowly recovered from total failure, and now the company may have two consecutive profitable quarters for the first time in six years. But can the stock price continue to rise higher?
Let’s review the chart during the last four years, when the company was not profitable. The price of the stock rose to $8 per share just on the hope that the company could become profitable, and then fell back below the $5 mark after the flash crash in 2010.
And remember, the last time the company was doing well enough to have two consecutive profitable quarters, the stock traded 5 times higher than it does today.
So bottom line: It’s still too early to know for sure if this trend will continue.
This stock has both higher risk and higher reward potential, which makes it a very attractive buy on dips. Investors might consider this stock as though it were a call option on the homebuilding sector. Expectations should be set for either a limited loss or a large gain.
The market is showing some warning signs that it could be in selloff mode for a period of weeks. HOV might be available for less than $5 a share during the next 60 days.
Recommendation: Buy HOV stock below $5.25 with a stop about one dollar below your entry point to protect risk. Consider taking profit if the stock makes a 50% to 100% rise during the first half of 2013. One final note: If the homebuilding sector continues its rise for six more months, investors may want to hold on even longer because HOV could rise significantly higher if the company turns in a string of profitable quarters.
Option Alternative: Our initial projections for HOV are likely to be met over the next six months. HOV has an active chain-sheet with call options expiring in May 2013 that we like as a way to leverage up the trade for a bigger potential ROI. We recommend the May 2013 $5 calls for $0.75 or less.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.
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