Throughout 2019, I’ve been ringing the bull horn on housing stocks — see here and here — claiming that recession fears which killed housing stocks in late 2018 were overstated. And that a plunge in rates on trade war fears, but against the backdrop of favorable labor conditions, created picture perfect conditions for the housing market in 2019.
Fast forward a few months. We are now nearly 10 months in 2019, and things have played out as expected. Rates have plunged. The U.S. labor market has remained healthy. The housing market has bounced back in a big way. So have housing stocks. The SPDR S&P Homebuilders ETF(NYSEARCA:XHB) is up 33% year-to-date, with many housing stocks having sprinted to decade highs in 2019.
Will the rally in this red hot group continue for the foreseeable future?
Probably. But at a more muted pace. The fundamentals here remain favorable. Sure, rates have crept higher over the past few weeks. But they remain well below where they were a year ago. The labor market remains healthy, supported by low unemployment and big wage gains. Credit is good. Homebuilder and consumer confidence remain healthy.
Net net, the fundamentals support further upside in housing stocks.
But the valuation underlying these red hot stocks already reflects this. That is, many of these stocks trade at decade high valuations. Are those rich valuations supported by strong fundamentals? Yes. But the multiple expansion driver that has underpinned the huge YTD rally in housing stocks should dry up soon.
As such, while I remain positive on the group going forward, I am less positive today, than I have been all year long. With that in mind, let’s take a look at 5 housing stocks which have sprinted to decade highs, and see where these stocks will go next.
LGI Homes (LGIH)
YTD Gain: 80%
One of the hottest housing stocks in 2019 has been U.S. homebuilder LGI Homes (NYSE:LGIH), with LGIH stock up 80% year-to-date to fresh decade highs.
The story at LGI Homes is simple. The company builds affordable, new construction homes in 26 markets and 16 states across the country. This gives LGI Home broad exposure to the low- to middle-income demographic across multiple geographies. This demographic tends to be very economically confident when the U.S. labor market is doing well and tends to spend big on big ticket projects when rates are low. That’s exactly what we have today. Thus, it should be no surprise that as rates have plunged and wages have gone up, LGI Homes has sold a lot of homes.
All of this should continue for the foreseeable future. The only problem is that LGIH stock trades at 14-times trailing earnings. That’s nearing a decade high valuation for this stock. Before, spikes towards a mid-teen earnings multiple have been unsustainable for LGIH stock. This history of volatility at these valuation levels gives me pause.
As such, on the heels of an 80% year-to-date rally, LGIH stock may be done rallying for the foreseeable future.
YTD Gain: 37%
When it comes to homebuilders, very few can match the breadth and depth of PulteGroup (NYSE:PHM), which has rallied nearly 40% this year to decade highs.
PulteGroup is big. They are the nation’s third largest homebuilder. PulteGroup also has healthy geographic diversity — they build homes across 25 states and in nearly 50 major markets — and equally healthy demographic diversity — their demographic portfolio breaks down roughly into 30% entry-level buyers, 30% move-up buyers, 15% luxury buyers and 25% active adult buyers.
Because of this wide exposure, as goes the U.S. housing market, so goes PulteGroup’s numbers. Thus, as the U.S. housing market has gained momentum in 2019 amid plunging rates and improving labor conditions, PulteGroup’s numbers have similarly gained momentum. As they have, PHM stock has soared.
The attractive thing about PHM stock? It only trades at 10-times forward earnings. Sure, that’s up big from where it traded at the beginning of the year. But it’s still just about average for a homebuilder, with the average forward earnings multiple in the homebuilding sector hovering around 10. It also comes against what analysts see as 13% EPS growth over the next few years.
In other words, despite a near 40% rally year-to-date, PHM stock is still cheap — too cheap considering its favorable growth fundamentals. As such, this stock can and should head higher going forward.
YTD Gain: 50%
Up 50% year-to-date and now trading at decade highs, homebuilder NVR (NYSE:NVR) has been a huge winner as the U.S. housing market has sprung back to life in 2019.
This should be no surprise. Much like PulteGroup, NVR is a big homebuilder with broad demographic and geographic diversity — the company builds homes in 14 states and 32 metro areas. Consequently, also much like PulteGroup, as goes the U.S. housing market, so goes NVR. So, as rates have plunged and incomes have climbed in 2019, NVR has sold a ton of homes at healthy profit margins — sparking a 50% rally in NVR stock.
Favorable growth drivers will remain in place for the foreseeable future. But valuation is a risk here. NVR stock trades at 18-times forward earnings. That’s nearly double the homebuilder market’s average 10-times forward earnings multiple. Also, that 18-times forward multiple is being awarded to NVR for reporting just 5% revenue growth and 8% net profit growth through the first half of 2019. That isn’t big growth. But 18 is a big forward earnings multiple for a homebuilder.
As such, the valuation on NVR stock seems too extended here. Further upside in the near term seems unlikely.
D.R. Horton (DHI)
YTD Gain: 49%
The number one homebuilder in America by closings volume — D.R. Horton (NYSE:DHI) — has naturally been a big winner in 2019 as the U.S. housing market has materially improved. Year-to-date, DHI stock is up 50%, and it presently trades right around decade highs.
There’s more to DHI than just being big. Specifically, DHI has dominant and leading market share in rapidly expanding metro areas like Phoenix and Dallas Fort Worth. Leading exposure to those hyper-growth markets gives DHI more growth firepower than most other homebuilders, and as such, DHI reported an impressive 11% revenue growth rate last quarter.
Despite being one the most impressive growers in the space, DHI stock trades at a fairly cheap 12-times forward earnings multiple. Sure, that’s above the homebuilder average multiple. But DHI is also growing more quickly than the average homebuilder. Indeed, a 12-times forward earnings for double-digit revenue growth seems like a steal.
Net net, DHI stock — despite being up nearly 50% year-to-date — may not be done rallying just yet, since the valuation here leaves room for more upside.
Meritage Homes (MTH)
YTD Gain: 92%
The biggest gainer on this list, and one of the hottest housing stocks in 2019, is Meritage Homes (NYSE:MTH), with a year-to-date gain of over 90%.
MTH stock is up big in 2019 because the U.S. housing market has sprung back to life, and that has recharged the Meritage Homes growth narrative. But MTH stock is up more than other housing stocks in 2019 because of favorable demographic tailwinds. That is, the big growth area in the U.S. housing market is Millennials finally moving out from their parents and buying their first home. This is what Meritage focuses on — building affordable, energy-efficient homes that are attractive to that cohort. Indeed, entry-level and first move-up purchases accounted for 90% of order volume in the second quarter of 2019.
As such, favorable demographic tailwinds have coupled with positive macro-economic housing conditions to turn MTH stock into a big winner in 2019. Can the rally continue? So long as those favorable demographic tailwinds drive better-than-industry growth, then yes. But as soon as those tailwinds dry up, MTH stock could drop, since it is trading at an above-sector average 13-times forward earnings multiple.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.