KB Home Stock Looks Set to Rise Much Higher as Home Buying Grows

KB Home (NYSE:KBH) seems set to rise much higher, especially since inventories are low and prices are rising. Moreover, KBH stock looks cheap on both an absolute basis — using historical dividend yield and price-to-earnings (P/E) — and also on a relative basis. My estimate is that KBH stock is worth 41% more to $55.53, over its Jul. 9 price of $39.52.

KB Home residential development project on Communications Hill in San Jose, South San Francisco Bay Area; KB Home builds homes primarily for first-time home buyers (KBH)
Source: Sundry Photography / Shutterstock.com

On Jun. 23, KB Home released earnings for the second quarter ending May 31. It showed strong growth in revenue and net income. Interestingly, though, the earnings release did not include cash flow information. The relevant 10-Q filing with this information has not yet been filed with the U.S. Securities and Exchange Commission (SEC).

That said, KB Home had a huge 58% gain in revenue year-over-year (YOY). In addition, it made a quarterly sequential gain of about 26%, up from $1.141 billion in sales during Q1. Moreover, the number of homes it delivered to buyers increased by 40%. This had a direct impact on its earnings, which were up 176% in the past year to $143.4 million.

One major factor that’s helping the company is that home selling prices rose 13%. Moreover, the company indicated that it has a $4.29 billion backlog of potential sales. It also indicated it expects its margins will allow a return on equity (ROE) of 20% going forward.

Valuing KBH Stock Using Dividend Yield

This high ROE allows the company to pay an ample dividend. For example, its shareholders’ equity stood at $2.887 billion as of May 31. So, if the company makes a 20% ROE, its net income will be $577 million.

Now, last quarter KB Home paid a dividend of 15 cents per quarter, or 60 cents annually. As the company has 95.379 million shares outstanding on a diluted basis, the dividend costs just $57.2 million annually. That is just 10% of its total expected net income. So, the dividend is well covered by its potential earnings.

Moreover, it also gives KBH stock a dividend yield of 1.51% (i.e., $0.60 / $39.52). But this is well below the company’s historical dividend yield. Seeking Alpha reports that KB Home has had an average dividend yield of 0.67% over the past five years. Substantially lower than the present 1.51% yield, this implies that KBH stock could rise nicely if it were to “revert to the mean” and sport an average dividend yield of 0.67%.

For example, if we divide 60 cents by 0.67%, the price target becomes $89.55 (i.e., $0.60/0.0067 = $89.55). This is about 127% over the current price of $39.52. That means that KBH stock could more than double if it were to rise to its average yield over the next several years.

Here is how that might work out. If it were to take two years for KBH stock to rise 127%, the average annual return on a compounded basis would be 50.2% each year. That means its price target this year is $59.36 per share (i.e., 1.502 x $39.52).

Other Ways to Value KB Home

Another way to value KBH stock is to compare it to other home builders. For example, according to Seeking Alpha the stock is trading on a forward P/E multiple of 5.30 times for 2022 earnings per share.

By comparison, MDC Holdings (NYSE:MDC) trades on a forward P/E multiple of 5.07 times. Meritage Homes (NYSE:MTH) has a forward P/E of 5.28, LGI Homes (NASDAQ:LGIH) is at 10.41 times, Lennar (NYSE:LEN) is at 7.18 times and Taylor Morrison Home (NYSE:TMHC) has a 4.35 times multiple. The average of all these five peers is 6.46 times 2022 earnings estimates.

Therefore, assuming KBH stock rises to the average 6.46 times, given its 2022 EPS estimate of $7.32, its price will be $47.28 per share. That implies a potential gain of 19.63% over today’s price.

Here is another way to value KBH stock. Morningstar has a valuation analysis of the company. It shows that in the past five years, the average P/E ratio for the stock has been 14.68 times. But right now, KBH trades for 6.15 times this year’s EPS estimate, according to Seeking Alpha. Therefore, KBH stock is worth about 139% more than today (i.e., 14.68/6.15 – 1 = 138.69).

What This Means for KBH Stock

So, assuming it takes two years for KBH stock to revert to this mean target price, the average compounded gain will be 50.98% annually for two years. The first-year target price is $59.66 (1.5098 x $39.52).

As a result, we now have three target valuation points. A dividend yield metric gives us a price target of $59.36. A peer valuation analysis yields a price of $47.28. And a historical P/E price target gives us $59.66. The average of these three is $55.53, or about 41% over today’s price.

As a result, look for KBH stock to rise at least 41% over the next year.

On the date of publication, Mark R. Hake did not hold (either directly or indirectly) any position in any security mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.

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