Homebuilding stocks are on fire with shares of the entire sector up nearly 40% on average since the middle of January. Is now the time to add shares of these fallen angels to your 401k? Let’s take a closer look at luxury builder Toll Brothers (TOL) to find out.
Last week the company announced a $96 million first quarter loss on falling revenue and plunging backlog. All told it was a horrendous report and with no end in site. Of course investors thought differently and sent shares higher. When stocks go up on bad news Rational Investors need to be cautious.
One explanation is that shares have fallen so far that short sellers are now buying to cover their positions and lock in profits. Maybe it was the announcement from the Federal Reserve that more interest rate cuts may be needed to prop up the faltering economy.
Who really knows? The market seems to have a mind of its own these days making it all the more important to use caution when deploying capital. CEO Bob Toll even said his company saw a few “glimmers of hope” in a couple of its markets, Naples, Florida and suburban Washington D.C.
Of course we’ve heard rhetoric to that effect from Mr. Toll before, way back in December ’06 when he famously said, “we may be seeing a floor in some markets where deposits and traffic, although erratic from week to week, seem to be dancing on the bottom or slightly above”.
Oh, to have only sold TOL stock then and gone short at that time!
It is quite perplexing as to explain the bullishness in the homebuilding sector. Statistics continue to deteriorate and there are grey clouds on the horizon. At a time when inventory of homes for sale are already high, interest rate resets on adjustable rate mortgages may greatly increase foreclosures.
There will be more supply than demand. Thus, this recent rally in homebuilding stocks is looking more and more like a dead cat bounce. These are the kind of moves that tend to be unsustainable.
I’m not buying it and you shouldn’t either.
There are too many things that can still go wrong with the sector. The economy has not yet reached a bottom, the financial sector is a mess, and inflation is nervously high. A lengthy contraction period may be on the horizon.
Topping it all off, the spring selling season for builders may be weak. If so, the homebuilding sector will fall further, including TOL. About the only good thing that can be said of TOL is that the company operates in the high end market that tends to be immune or at least less impacted by an economic slow down. In addition, TOL has a strong balance sheet, one of the best in the business. They have more than $950 million in cash and about $1.2 billion available on a credit facility. Shares trade for just about book value.
Historically it has been a great buying opportunity to buy homebuilders when shares trade for 80% of book value. We were there, but no longer. That tells me there could be more downside for TOL and other builders.
If you are thinking about adding shares in your 401k, I would suggest patience. The road is still bumpy out there.
Jamie Dlugosch
Executive Editor, InvestorPlace
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