Toll Brothers Takes a Hit, But Don’t Count It Out Yet (TOL)

Toll Brothers (TOL) stock fell sharply Tuesday after solid earnings growth failed to meet Wall Street’s forecast, and that selloff could portend a rougher start to 2016.

Toll Brothers Takes a Hit, But Don't Count It Out Yet (TOL)

True, it’s possible analysts set the bar too high amid overconfidence in a much-improved housing market. After all, it has been something of a mixed earnings season for the big housing stocks.

Lennar Corp. (LEN) and KB Home (KBH) beat the Street’s top- and bottom-line forecasts earlier in the reporting season, while DR Horton (DRI) missed on revenue and PulteGroup (PHM) fell short of sales and earnings per share.

Either way, a housing market that hasn’t been this good since before the bubble burst isn’t translating into the unblemished results that analysts want to see.

Housing stocks have shrugged off any disappointing news this year to put up enviable gains. Indeed, the PHLX Housing Sector Index is up more than 10% this year to beat the market by a wide margin. Prior to the post-earnings selloff, shares in Toll Brothers were up 9.5% for the year-to-date.

Bullishly, the sector produced those returns even with an interest-rate hike looming over it.

But whether they can maintain that outperformance next year is what should be foremost in investors’ minds. Rates are almost certainly going up before the end of December and mortgage rates will go with them.

A Mixed Market for TOL

It’s also not as if the housing market has delivered only good news. Rather, it’s been mixed. U.S. housing starts fell to a seven-month low in October, but single-family building permits — and indicator of future growth — hit their highest level since 2007. New home sales rebounded in October after a late summer slump, but existing home sales fell 3.4%.

The implications of higher rates should already be discounted in stocks like TOL, but you can still bet that shares in the sector will move lower when it actually hits. Furthermore, investors might take a wait-and-see approach on how higher rates are affecting Toll Brothers and other housing stocks.

And then there’s the case that sometimes the most successful stocks in one year fall out of favor the next.

Still, investors in TOL should be happy with the company’s results, which were strong on a fundamental basis. Toll Brothers said net income rose to $147.2 million (or 80 cents a share) from $131.5 million (or 71 cents a share) a year earlier. Analysts, on average were looking for earnings of 83 cents a share, according to a survey by Thomson Reuters.

Revenue rose 6.4% to $1.44 billion to pass the Street forecast of $1.43 billion.

Importantly, TOL’s signed contracts grew 29% in value year-over-year, average price increased 15% and backlog jumped gained 10%.

The rate hike and new year could make TOL more of a sideways trade until the market feels comfortable again, but that shouldn’t last. As long as the housing market continues to progress, TOL stock looks fine.

As of this writing, Dan Burrows does not hold a position in any of the aforementioned securities.

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