Housing stocks have been on fire since mid-March, on optimism that a swift recovery in the housing market is on the way. One of the housing stocks at the head of this rally has been that of the nation’s leading luxury homebuilder, Toll Brothers (NYSE:TOL). Over the past three months, TOL stock has more than doubled.
Is it time to take profits? I don’t think so.
It’s just the opposite. I think it’s time to buy and double down on TOL stock.
A Huge Recovery Is Coming
But those numbers represent home closing contracts that were signed in February, March and April. Things have improved dramatically since then, and the big-picture fundamentals imply that the U.S. housing market is on the cusp of a huge recovery.
Starting in May, the U.S. economy has begun to gradually reopen and recover from the novel coronavirus. That’s not to say that the pandemic is over. It isn’t. But it is to say that consumers and companies alike are learning how to keep the world turning while managing Covid-19 risks. Both parties will only get better at this balancing act over the next few months. As they do, U.S. economic activity — and by extension, the housing market — will perk up.
At the same time, mortgage rates are at all-time lows, everyone is saving their paychecks today, millennials are finally moving out and the U.S. homeownership rate is rising off multi-decade lows. There’s ample room for further gains behind drivers such as low rates, pent-up demand and huge savings accounts.
The fundamentals underlying the U.S. housing market are actually quite strong. In sum, they imply that the worst of the housing market’s dip is over, and that brighter days are ahead for U.S. homebuilders like Toll Brothers. That spells good things for TOL stock.
Boomers Are Downsizing
The really unique and exciting aspect of Toll Brothers is its new Active Adult unit, which is an optimal play on one of the housing market’s biggest demographic trends. What is this trend? Baby boomers are downsizing in record numbers.
More than a third of today’s homeowners are over the age of 50. Those boomers are ready to downsize. This downsizing dynamic will be accelerated by new millennial homebuyers who will inject more liquidity into the market. Consequently, over the next few years, baby boomers downsizing will represent one of the biggest growth verticals of the housing market.
Toll Brothers has recently built out a segment called Active Adult, which is the company’s best effort to capitalize on this demographic trend.
The Active Adult unit focuses on creating luxurious, low-maintenance living accommodations for the 55-and-over crowd. It’s essentially an ideal downsizing option for middle-to-upper income retirees.
As such, over the next few years, Toll Brothers is well positioned to sell a lot of Active Adult units. As it does, Toll Brothers’ whole growth narrative will get some extra juice coming out of the current crisis.
Arguably the best thing about TOL stock here and now is that it’s undervalued.
Before Covid-19 emerged, Wall Street’s consensus fiscal 2021 earnings per share estimate for Toll Brothers stood at $4.50. That estimate has since plunged to below $3.50.
As the housing market recovers over the next few months, Toll Brothers will report above-consensus numbers and deliver better-than-expected forecasts. Analysts will be forced to lift their estimates. I wouldn’t be surprised for this dynamic to eventually push fiscal 2021 earnings per share estimates back to $4.50 by the end of 2020.
Assuming so — and further assuming that TOL stock sustains a historically average 10-times forward earnings multiple — then we are talking about a potential $45 stock by the end of the year.
That implies 40%-plus upside in TOL stock over the next six months, which is likely more upside potential than you will find anywhere else in the homebuilding sector.
Bottom Line on TOL Stock
The housing market is on the cusp of a huge recovery. Toll Brothers is one of the more attractively positioned homebuilders in this recovering market. And TOL stock is arguably the most attractively valued stock in this space.
Put it all together, and it’s easy to see why TOL stock is a strong buy here.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the best stock pickers in the world by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.