Housing: The Next Big Sector to Rally?

With the S&P 500 up some 20% from the lows, and the Nasdaq solidly in positive territory for 2009, we can safely say that a bottom has been reached in the overall market.

But what about the housing sector? This was, after all, where the market downturn started.

Over the last year or so, there have been multiple calls of the bottom. Those predictions have all failed. The housing sector
continues to be weighed down by rising foreclosures and falling prices. Inventory remains persistently high, and homebuilders are applying for fewer permits for new construction. These are hardly fertile grounds for homebuilding companies to make and grow profits.

But recently, the picture has changed. Home sales are showing some strength. Yet prices continue to fall. Why?

The decline in price can be attributed to auction liquidation of bank-owned and foreclosed properties. I suspect things are
better than they seem, and that the elusive bottom is here.

Here then are four housing stocks that are well-positioned for a turnaround…

Housing Stock #1: Pulte Homes (PHM)

Pulte Homes (PHM) was one of my picks for the Top 10 Stocks for 2009.

Before the company announced an acquisition of Centex (CTX), shares of PHM had been up 50 cents since the beginning of the year. After the news, the company shed more than 10% of its market value. At a price below $10 per share, PHM trades for less than one times book value. Historically, owning homebuilders at a price below book value has been prudent.

Use the market discount of the acquiring firm, PHM as an opportunity. I wouldn’t want to wait much longer for confirmation of a bottom. We may have just received that confirmation with this significant deal. Analysts expect PHM to earn a profit in fiscal year 2010. The stock should rally in advance of that moment.

I would buy PHM up to $12 per share with a target of $20 in three to five years.

Housing Stock #2: KB Home (KBH)

KB Home (KBH) is one of the largest homebuilders in the country, with most of its business in markets that are suffering the greatest during this decline. In fact, some might contend that KBH is to blame for the massive overbuilding that triggered the collapse in the real estate market.

KBH stock has suffered greatly for that sin, with shares well off their $80 peak valuation. 2009 is a new year, though, and
KBH has bounced off its lows. Shares are up more than $1 per share and are trading around $15 per share. At that price, KBH has a bit of a premium valuation, trading for just under 1.4 times book value. It, too, is expected to earn a profit in fiscal year 2010. And though a return to record volumes is unlikely, I do expect KBH to recover much of its lost value over the next few years.

Housing Stock #3: Toll Brothers (TOL)

Luxury home builder Toll Brothers (TOL) has fared better than its peers during the homebuilding collapse. Its high-end product serves a segment of the population that can better withstand the economic crisis. Though shares have lost more than half their value, TOL has found support at the $20 level.

So far, that support has provided little upside this year. While other homebuilders have gained in value, TOL actually trades
lower than it did at the start of the year. With the short-term weakness, TOL shares trade for less than book value.

That makes the company a screaming buy in my opinion. Serving the high-end market allows TOL to make a larger profit margin. Assuming profits do return in 2010, TOL could see an acceleration in price to the upside even greater than its peers.

Housing Stock #4: D.R. Horton (DHI)

One of the biggest gainers in the market this year is D.R. Horton (DHI). At the start of 2009, investors could own the company for just over $7 per share. Since then, DHI shares have rallied to nearly $12. That is heady stuff, considering the market has traded down this year.

Granted, the prospects for DHI looked considerably gloomy at the end of 2008. Many were concerned that the company was headed to bankruptcy. Clearly, the market decided that fears of DHI’s demise were premature, sparking an intense short cover rally.

The good news is there is more meat on the bone. Even with the gains, DHI trades for just over 1 times book value. Analysts expect the company to make 13 cents per share in 2010. It is not unlikely for the company to double that profit level over the long haul.

I would own DHI up to $12 per share, and my target is $20.