Despite housing recovery, housing stocks are a sell

The optimism is priced in, and upside from here seems unlikely.

By InvestorPlace Feb 8, 2013 12:41PM
iplogoHome under construction CorbisBy Jeff Reeves

Homebuilders and housing stocks have been on a big run lately. The SPDR S&P Homebuilders ETF (XHB) is up over 40% in the past 12 months, more than tripling the broader S&P 500 Index ($INX).

High fliers in the sector are up even more dramatically, including almost 140% gains for PulteGroup (PHM) and almost 90% gains for Ryland (RYL).

But there's a reason to think the music is going to stop for housing stocks even if real estate data continue to improve. Much of the optimism is already priced in, and year-over-year growth is going to rapidly become less impressive.

Consider Home Depot (HD). The big-box home improvement store is up more than 40% in the past 12 months and 90% since the beginning of 2011. If you bought a year or two ago, that was a great move. Momentum has slowed to a crawl, with just 5% revenue growth forecast for fiscal 2013 and a measly 3% in fiscal 2014. Sure, earnings are better, but after the projected 25% earnings per share increase or so in fiscal 2013, a much more modest growth rate of just 10% or so is forecast for fiscal 2014. Despite the fact that growth is waning and year-over-year results will be flat in just a quarter or two, it boasts a forward price-to-earnings ratio of 19.

The story is similar for Lumber Liquidators (LL). The forward price-to-earnings ratio is over 29 after a stunning 160% run-up in the past 12 months and 660% from March 2009. Growth estimates are more robust than Home Depot, with sales forecast to grow by the double digits this year and next and a projected 25% earnings increase. But you're telling me that growth isn't already priced in after that parabolic rise? I'm going to go out on a limb and say the word is out on this momentum play.

The builders are more hit-and-miss. Some see most of their growth ahead of them and only modest appreciation in shares that could leave more upside. But a handful seem very overheated -- including aforementioned winners Ryland and Pulte. Barclays recently downgraded Ryland to "underweight" with a $35 target -- lower than current valuations -- after its meteoric rise. Same for Pulte, which was lowered to "hold" at Deutsche Bank with a $17 target.

Then the ultimate in contrarian signs: The January IPO of TRI Pointe Homes (TPH). Shares are down almost 8% in just a few trading days.

Let's admit a hard truth about investing: Wall Street doesn't really care about your cost basis or personal experience with a stock. Whether you're up 700% or currently suffering a margin call is academic -- the market is pricing stocks based on current investor interest, current headlines and future forecasts.

So while the big gains in housing stocks may have you puffing out your chest, now might be a smart time to take profits. After all, what about the current situation in housing makes you think these gains will keep up and deliver outperformance from this moment in time? What makes you think the market hasn't already priced in the optimism and is now actually pricing in significant earnings growth and favorable housing news -- leaving the door open for disappointment even if future headlines are "less good" than desired?

Look at housing stocks in a vacuum and ask yourself if this is a buying opportunity. I think most investors will agree it is not.

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