After briefly crashing in March on novel coronavirus fears, homebuilding stocks have been on fire over the past three months, with the SPDR S&P Homebuilders ETF (NYSEARCA:XHB) up 70% over that stretch. KB Home (NYSE:KBH) stock has been no exception to the trend. Instead, it’s been a leader in this recovery rally.
KBH stock is up a jaw-dropping 180% over the past three months.
With KB Home’s second-quarter earnings just around the corner, some investors may be saying that now is the time to cash in on this red-hot rally.
But I don’t think that’s the right move.
Instead, I think the right move here is to stick with the red-hot rally in homebuilding names like KBH stock. This group and this stock are only going to keep powering higher over the next few months.
Homebuilders Are a Strong Buy
In this environment, homebuilding stocks are a strong buy for a few reasons.
First, the economy is gradually reopening and recovering from a complete shutdown in March, April and May, thanks to Covid-19 fears. Those fears are now abating. The world is now learning how to keep turning while managing Covid-19 risks (as opposed to completely shutting down). As the world gets better at this balancing act over the next few months, economic activity will continue to pick up. So will buying and selling activity in the housing market.
Second, existing homes sales have plunged over the past few months. But, as we all know, housing demand is a secular thing — it won’t permanently die because of a virus. So, in essence, the plunge in existing home sales over the past few months has just created pent-up demand for home buying. That pent-up demand will be unleashed over the next few months as the U.S. economy gradually normalizes.
Third, mortgage rates are at all-time lows, and with the U.S. Federal Reserve seemingly committed to keeping its benchmark interest rate at or near zero for the next 12-18 months, record-low mortgage rates are here to stay for the long haul. Low rates mean cheaper financing. Cheaper financing attracts more homebuyers.
Fourth, everyone is saving their paychecks today, providing ample ammunition for home-buying firepower in the coming months. That is, the U.S personal savings rate rose to a multi-decade high of 12.7% in March, and an all-time high of 33% in April. All of those savings provide U.S. consumers with ample firepower to allocate into the housing market in the second half of 2020 and throughout 2021.
Fifth, millennials are finally moving out, and the U.S. homeownership rate is rising off multi-decade lows. Still, the U.S. homeownership rate today sits at just 65% — well below the 70% levels it was at in 2004-05. Drivers such as low rates, pent-up demand and huge savings accounts should help accelerate the “millennials moving out” trend and push the homeownership rate back up toward its all-time highs.
KB Home Stock is a Strong Buy
In the strong homebuilders groups, KBH stock is one of the strongest buys, also for a few reasons.
First, the company is focused on selling new, entry-level homes to first-time homebuyers. That’s the perfect market to be in right now, because of the “millennials moving out trend.” As such, as the housing market bounces back over the next few months, KB Home’s volume and sales trends should rebound more meaningfully and more quickly.
Second, the company is also focused on creating environmentally conscious homes powered by solar energy. That’s a big deal, since the company sells to a millennial, first-time homebuyer crowd that wants to purchase an environmentally conscious home. Nearly half of millennial homebuyers want both solar panels and energy storage in their home.
In other words, KB Home makes the perfect type of home, for the perfect market.
Third, KBH stock is undervalued. Before the Covid-19 pandemic emerged, KB Home’s consensus fiscal 2021 earnings per share estimate sat around $4. It has since plunged to below $3. Given the aforementioned favorable trends, I suspect that fiscal 2021 earnings per share estimates will rebound over the next few months alongside rebounding housing market activity.
I see it as likely that, by the end of this year, fiscal 2021 profit estimates rebound to $3.50-plus. Based on a historically average 10.5-times forward earnings multiple, that implies a 2020 price target for KBH stock of $37-plus.
KBH stock trades closer to $32 today.
As such, this red-hot rally in KB Home stock isn’t over just yet.
Bottom Line on KBH Stock
KBH stock has been on fire ever since March. Some investors are concerned that KB Home’s earnings report — due this week — will short-circuit that red-hot rally.
It won’t. The fundamentals underlying the homebuilders segment and KBH stock remain very favorable. The valuation similarly remains favorable. So long as those two things remain true, KBH stock will powering higher.
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.