Just under a year ago, I wrote a piece on InvestorPlace.com wherein I said that housing stocks were positioned for a huge rebound in 2019, after a sub-par 2018 showing. Fast forward twelve months. Year-to-date, the SPDR S&P Homebuilders ETF (NYSEARCA:XHB) is up an impressive 40%, marking its best annual performance since 2012.
In other words, heading into 2019, I was exceptionally bullish on housing stocks, and those stocks proceeded to have their second best year of the decade.
Heading into 2020, though, I’m less bullish, and more cautiously optimistic.
That is, I’m optimistic on housing stocks sustaining their rally. Housing market fundamentals should remain largely positive over the next twelve months, characterized by continued strong labor conditions, low mortgage rates, healthy demand from first-time home-buyers, steady supply growth and gradual home price gains.
But, I’m also cautious on the idea that valuation and positioning could limit how much higher these stocks go. Specifically, heading into 2019, housing market fundamentals were set to improve, and housing stocks were not priced for this improvement (they were dirt cheap at ~8-times forward earnings, and were coming off a 27% selloff in 2018). That created a compelling buying opportunity. Heading into 2020, however, housing market fundamentals are still set to improve, but housing stocks are now priced for this improvement (the forward earnings multiple has expanded to 11, and the group as a whole rose 40% in 2019).
Because of this, while I think housing stocks can and will continue to rally in 2020, the magnitude of that rally will be much smaller than the gains these stocks posted in 2019.
With that in mind, I’ve put together a list of five hot housing stocks that I think can outperform in 2020.
Hot Housing Stocks: LGI Homes (LGIH)
YTD Gain: 56%
With operations in 26 markets and 16 states, home-builder LGI Homes (NYSE:LGIH) looks well positioned to benefit from macro U.S. housing market tailwinds in 2020. Also of note, LGI Homes has a big presence in the important and rapidly growing San Antonio, Dallas/Fort Worth and Houston housing markets.
It should be no surprise, then, that analysts are calling for 15%-plus profit growth at LGI Homes next year.
More than that, though, LGIH stock trades at just 10.4-times forward earnings, which is below the homebuilder sector average forward earnings multiple (10.9). If LGI Homes does rise with the housing market in 2020 — as it should — then the stock’s underlying multiple should expand about 5% to be on par with the industry’s multiple.
In other words, LGIH stock is in a great position to move higher in 2020 thanks to robust profit growth and multiple expansion. Put together, 15%-plus profit growth and ~5% multiple expansion could easily push LIGH stock another 20% higher in 2020, after a 50%-plus gain in 2019.
Lennar (LEN)
YTD Gain: 43%
Much like LGI Homes, Lennar (NYSE:LEN) is a big home-builder with enough geographic and demographic diversity to ensure that macro U.S. housing market tailwinds turn into sustained growth at the company in 2020. In particular, Lennar has a large presence in the apartment world, and recent data implies that this vertical of the housing market is a growth one.
That’s why Lennar’s profits are projected to rise about 7% next year, according to Wall Street estimates.
At the same time, LEN stock trades at just 9.2-times forward earnings. That’s about as cheap as it gets in the homebuilder category. It’s also well below the stock’s five-year average forward-earnings multiple of nearly 11.
Given that the industry average forward earnings multiple is also 11, it’s not that far fetched to think that LEN stock’s forward earnings multiple expands meaningfully in 2020. That meaningful expansion on top of mild profit growth should drive healthy gains in LEN stock.
D.R. Horton (DHI)
YTD Gain: 53%
The No. 1 homebuilder in America by closings volume — D.R. Horton (NYSE:DHI) — had a strong 2019, rising more than 50%. More importantly, though, America’s largest homebuilder is in a great position to keep running higher in 2020.
The thesis is quite simple. As the country’s biggest homebuilder, D.R. Horton goes as the U.S. housing market goes. The U.S. housing market is going higher in 2020. So will D.R. Horton’s revenues and profits. Analysts are calling for profits at the company to rise more than 7% next year.
Simultaneously, DHI stock trades at 10.9-times forward earnings. That’s below the stock’s five-year average 11.4-times forward earnings multiple. Given the favorable growth backdrop and DHI’s favorable positioning in the housing market, there’s no reason why DHI stock shouldn’t trade at its historically normal 11.4-times forward earnings multiples. Thus, DHI stock could benefit from ~5% multiple expansion in 2020.
Roughly 7% profit growth on top of 5% multiple expansion should drive a 10%-plus gain in DHI stock in 2020, after a 53% up year in 2019.
KB Home (KBH)
YTD Gain: 78%
Homebuilder KB Home (NYSE:KBH) was one of the best performing housing stocks of 2019, rising a whopping 78% behind community count growth, gross margin expansion and robust profit growth. Fortunately for bulls, it looks like KBH stock may yet again be another top performing housing stock in 2020.
Favorable housing market conditions will keep KB Home’s revenue and profit trends healthy in 2020. Sustained community count growth will also juice the company’s growth trajectory, while rising prices will provide a lift to gross margins. Thus, the sell-side consensus projection for 8% profit growth in 2020 seems entirely doable.
Meanwhile, KBH stock trades at just 9.9-times forward earnings. That’s one of the lowest multiples in the entire homebuilder group. It’s also well below the industry average 10.9-times forward earnings multiple, and KBH’s five-year average forward earnings multiple of 10.8. This discrepancy will likely fade in 2020 as KBH sustains robust profit growth against a healthy operating backdrop. As it does, KBH stock could benefit from ~10% multiple expansion.
Putting those two drivers together, sustained profit growth and multiple expansion could drive a 20%-plus gain in KBH stock in 2020. By my projections, that would make KBH stock one of the best performing housing stocks in 2020.
Toll Brothers (TOL)
YTD Gain: 21%
Although homebuilder Toll Brothers (NYSE:TOL) rose 21% in 2019, that performance was weak relative to the rest of the group — the other four stocks on this list rose more than 40% in 2019. This 2019 under-performance, however, positions the stock for over-performance in 2020.
In 2019, Toll Brothers’ gross margins struggled. Those gross margin struggles should ease in 2020 as demand trends in the housing market improve, and as Toll Brothers expands more aggressively into the affordable housing vertical (which is where a lot of growth will come from in 2020). A rebound in gross margins will drive super-charged 2020 profit growth, since the 2019 lap is low. As such, analysts are calling for 15% profit growth next year.
That’s a lot of profit growth. And yet, TOL stock trades at just 10.3-times forward earnings — which is cheap on its face, cheap relative to the homebuilder category and cheap relative to TOL’s trailing five-year standards. Thus, a gross margin rebound in 2020 could also spark multiple expansion for the stock.
This combination of multiple expansion and 15% profit growth should drive sizable gains for TOL stock in 2020.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
