2 Home Builders To Buy And 1 To Avoid

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Many home builders are still recovering from the housing collapse in 2008. While the housing bubble wasn’t entirely their fault, like investors, they got caught up in the hype. They made bad business decisions thinking that the good times would never end.

When the good times did end, the home builders were left scrambling. Many lost money. Others went out of business. But the housing market has slowly regained steam and has been performing well in the past 5 years.

This is mainly thanks to the low interest rate environment we are in. With low interest rates, housing is more affordable and consumers are willing to make the big decision on buying a home.

With the recent turnaround in the housing market, today we are going to look at 2 home builders to buy and 1 to avoid.

2 Home Builders To Buy

#1. Meritage (NYSE: MTH)

Meritage isn’t one of the home builders many people know of. But based on the company’s performance, they should be on your radar. They are a home builder that has focused its growth in the central and western parts of the U.S. and now are expanding east.

For the first quarter, they reported pre-tax earnings up 27% and diluted earnings per share up 12%. They also confirmed their outlook for full year 2017.

And the future looks bright for Meritage. They are planning on building more communities, both in the strong western and central parts of the country but also in the east as well. They are also working to improve gross margins so that they can squeeze more value out of every dollar they make.

The goal for gross margins is 20%. For the first quarter, they hit 16%. For full year they expect to hit 17.5%. In other words, they are well on their way to achieving this goal and the stock is one you should consider investing in.

#2. NVR Homes (NYSE: NVR)

NVR Homes focuses on affluent home buyers. For the first quarter of 2017, they reported an increase in revenue of 12% to $1.28 billion. Their first quarter earnings per share beat estimates by $4 at $25.12.

There are a couple of things about NVR that make the home builder stand out. First, you have their approach to land buying. Most home builders buy land they want to build on. This strategy worked well until 2008.

At that time, prices dropped and home builders were left with the debt from the purchase and not able to build any homes. This wreaked havoc on balance sheets. NVR doesn’t do this. They option land instead of buying it.

This allows them to keep steady cash flows and predictable profits, even when the market turns south.

Another thing NVR is doing is a massive share buyback program. This has increased shareholder value tremendously in the past few years.

Because of the strong growth and steady, predicable nature of this stock, it should be one of the first ones you turn to when looking to invest in this industry.

1 Home Builder To Stay Away From

Toll Brothers (NYSE: TOL)

Toll Brothers builds luxury homes. When I say luxury homes, pricing usually starts in the mid $700,000 range for their homes.

The company recently reported first quarter earnings and revenue came in at $921 million and orders were up 22%. Net income was reported to be $70 million and the company confirmed they are on track to meet their guidance for full year 2017.

So why stay away from this home builder? First, is the change in demand. More home buyers are seeking housing in urban areas that provide convenience. Toll Brothers typically builds in the suburbs.

Related to this is the more and more people are looking at smaller housing. The large McMansion houses that were popular during the housing boom are falling out of favor. I feel that in the coming quarters, new orders will drop for Toll Brothers.

Finally, there are the pending lawsuits. Many high end homes that Toll Brothers builds have stucco. During the housing boom, builders cut corners and installed stucco and other building materials incorrectly.

Many homeowners are now bringing lawsuits against the home builders as repairs on a single home can exceed $100,000.

According to Toll Brothers, they estimated the liability for repairs to be $80.3 million. Looking at the company’s 2016 Annual Report that number has now ballooned to $324.4 million.

If the company is found to have to pay out damages, the stock will suffer.

Final Thoughts

The housing industry is cyclical and does fall. While I don’t see a fall like we saw in 2008, you don’t know when the next pull back will be. Could housing slow down now because interest rates are rising? Possibly. But with how slowly rates are rising, it shouldn’t have a dramatic impact on home builders.

For anyone interested in investing in this sector, invest knowing that it is cyclical and that downturns do happen. Have an exit strategy and you should be OK in the long run.

This author has no positions in any stock mentioned and does not plan to open any positions in any stocks mentioned for at least 72 hours after publication of this article.