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Builders Have Further to Fall

Homebuilder stocks continue to be slammed, and gauging just how far they may fall is getting ever-more difficult.

In the past, the thinking was that you should buy homebuilder stocks when they trade near book value, because historically the stocks head up from there. So long as builders made money from selling homes, or land values went up, the book value would also increase and so would stock prices, the theory held.

That model has been blown up.

The entire homebuilding sector is in danger of reporting losses for the year because of falling housing prices and high inventory levels. At the same time, land values continue to drop, requiring builders to record large impairment charges. Both issues further cut book value at the companies.

(As a reminder, a stock's book value is simply the stated value of shareholders equity on the balance sheet, divided by the number of shares.)

"These stocks could have a 10% to 15% leg down again because book value keeps falling. It is a moving target," says an analyst at a hedge fund that is shorting the sector.

Last week, Lennar (LEN - Get Report) and KB Home (KBH - Get Report) set the tone for the ugly results ahead for the sector, as both firms reported unexpected quarterly losses because of large land impairments, which eroded book value.

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