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Toll Brothers' Profit Boost Doesn't Signal Stock Buy

Stocks in this article: TOL LEN PHM DHI

NEW YORK (TheStreet) -- Homebuilder Toll Brothers (TOL) said Wednesday that its profits doubled during the third quarter of its fiscal year, ending in July. Don't get carried away, though -- it's still too early to buy the stock.

Profit rose 110% to $97.7 million, or 53 cents a share, which beat analyst estimates by a tidy eight cents. Normally that would make the stock pop. But Toll dropped 3.25% as of 11 a.m. to $34.48.

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The reason is a 6% decline in the number of new homes ordered during the quarter, which points to soft revenues in coming quarters when those deals would close. The average Toll Brothers community sold one home fewer than in the same quarter of last year, for an overall decline of 80 homes at an average price tag of $717,000. Toll Brothers also lowered the top end of its guidance for this year, saying it will deliver between 5,300 and 5,500 homes rather than the previous estimate of 5,100 to 5,850.

Toll's strategy, which management will explain in more detail later today, is to manage the company for profit now while positioning itself to ride any wave of pent-up demand as the economy improves. But the company concedes that that wave has not shown up yet, and that its pricing power is weakening, if slightly.

The profit gain came from better margins, including a drop in selling and overhead expenses. That points to the determination to manage the company for short-term profitability. The long-term strategy shows up in moves like the company's push into apartment construction as well as its boast that its portfolio of buildable lots is the best in the industry. Its evidence: a Builder magazine report saying Toll's lots on average are in better school districts than rivals like Lennar (LEN) , Pulte (PHM) and D.R. Horton (DHI) .

The company tried to spin a little bit better news about what happened in August, saying buyer traffic at its communities rose 13% and the number of non-binding deposits was up 18%. (Because Toll Brothers has more communities selling than it did last year, the traffic gain is only 4% at the average development.)

But signed contracts were down sharply -- 7% overall and 19% per community, about the same as in the third quarter.

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The August pop in traffic may yet produce a turn in contracts signed, and with it more big profit gains in quarters to come. But the reduction in the top end of the company's forecasts shows management doesn't have confidence in that yet -- and it's citing the same confusing macro data on housing starts and sales that has been alternately baffling and discouraging the market. 

You shouldn't have too much confidence in this market yet either.

At the time of publication, the author held no positions in any of the stocks mentioned.

Follow @timmullaney

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

TheStreet Ratings team rates TOLL BROTHERS INC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate TOLL BROTHERS INC (TOL) a BUY. This is driven by some important positives, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its robust revenue growth, largely solid financial position with reasonable debt levels by most measures, increase in net income, good cash flow from operations and growth in earnings per share. We feel these strengths outweigh the fact that the company has had somewhat disappointing return on equity."

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