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Is Pulte Worth a Shot?

The parallels are meaningful, and barring economic Armageddon, the group should be profitable.

This story was originally published Jan. 31 at 9:17 a.m. EST. It's being reprinted as part of the Breakout Stocks promotion.

Check out the chart of

U.S. Steel






Commercial Metals



Pretty impressive rallies wouldn't you say? Many of the stocks have doubled since June.

Six months ago, the only steel chatter on the Street originated from the short sellers and contained the disaster scenario for steel: supply exploding, inventories building, prices plunging and earnings faltering. Does that same story sound familiar with respect to any other down and cheap stock market sector?

It's the same bear story on the housing market and homebuilders right now! From the relentless negative spin on


to my neighborhood cocktail parties, the impending housing collapse is

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big story. And, it is spoken with such absolute certainty by market commentators that a positive case for the homebuilding stocks is immediately greeted with ridicule and derision.

That's fine with me. In fact, it's the way I like it. I am back to buying homebuilder stocks again. I bought them and sold them before, and I will probably trade them again this year. But down and cheap with good fundamentals is what I buy, and boy, do homebuilders fit that bill.

The housing stocks represent the cheapest sector of the stock market today bar none. And that's because everyone knows the negative case for housing prices and housing demand. Let's just say "down" is not strong enough a word. And, if everyone (and I mean everyone, since Alan Abelson would get this right) is correct and the housing market collapses, the homebuilding shares will suffer. And so will the economy and so will the stock market.

Depending on the severity of the industry decline, the homebuilding stocks could decline 25%-30%. In that bad a real estate bear market, the implications for the financial markets suggest a similar decline in the market indices. That's the benefit of buying stocks trading at price/earnings ratios of 6 instead of ones trading at 19.

But what if "everyone" is wrong?

What if the past is prologue?

What if the real estate market digests its gains by flattening out for a few years and not collapsing?

What happens if housing demand holds up acceptably on the backs of decent economic growth, strong employment gains, favorable demographics, firm financial markets and peaking interest rates?

What if the biggest bubbles are in the brains of the building stock shorts?

Ignore Current Facts, Focus on History

Well, that's a different story. Like the steel short sellers, the housing shorts will get their proverbial heads handed to them.

Now, I know I cannot convert housing bears to bulls with any amount of fundamental research.

Past examples of soft landings in the real estate industry mean nothing.

Demographic-driven demand counts for zip. Secular market share gains by large public builders are irrelevant.

Even charts comparing housing starts to domestic households, which reveal "normal" supply/demand conditions get dismissed.

So I will not clutter this column with facts and data. I do not want to impair the bears' opinion with potentially contrary facts.

But I can prove that, right there in front of our nose, was a big, fat trading opportunity in a sector very similar to homebuilders today.

Six months ago, steel stocks were down and cheap and the fundamentals were on the cusp of collapse. Yet the end never came. The steel business experienced a soft landing. Demand cooled and prices fell, but then business stabilized. Like the industry, many steel companies are posting flat or declining revenues/profits. Things are just OK, and the forecasts are for more of the same.

But boy-oh-boy look at those stocks: Nucor up 90%, U.S. Steel up 75%, Commercial Metals up 100% from last summer lows! It seems to me as if investors, in an orgy of pessimism, passed up an excellent investment opportunity.

Could homebuilders be providing the same opportunity? Maybe. The steel stock analogy alone should have you interested.

So which homebuilders would I use to participate in this contrary trade? In a soft landing scenario, most of the stocks will work. If dollar volume of new-housing sales grows in only the low single-digit range, the stocks will appreciate magnificently, probably moving about the same percentage as the aforementioned steel trade.

However, since ownership of a homebuilder is such a contrary move, I'd suggest one of the most defensive names in the group,

Pulte Homes


. Pulte has some of the best geographic and market segment diversification of any public builder. This reduces the exposure to any one region or class of home buyer. The company also has, with its Del Webb division, the best demographic play in the industry, the growth in active adult communities. At 35% of Pulte's deliveries and growing, this very stable source of demand is demographically driven and not as sensitive to interest rates or speculative forces.

If the housing market does indeed roll over, Pulte has the diversification across regions, buyers and demographics to preserve its income statement better than most if not all of its peers. So if you need some downside protection in order to purchase a homebuilder, choose Pulte. In a flat housing market, the stock will provide more than ample appreciation potential.

The next few months are prime selling season for new homes. I expect good news. As everyone knows, the bull market in housing is over, so expectations are low. High consumer confidence, an improving job market, favorable weather conditions and modest comparisons from 2005 all support the case for decent housing numbers through the spring. Don't get me wrong, orders and sales will range from down a little to up a little. It's nothing exciting, and not unlike those recent steel industry conditions.

But as investors realize that the housing market is not collapsing the stocks that are at 6 times earnings, will rally. At first, the rally will be gradual because investors will still harbor fears of a housing debacle. But deeper into the soft-landing scenario, and just like steel stocks today, the rally will accelerate.

Ignore the foolish analysts who claim slowing growth this year or next or cite a downturn in 2008 as reasons to avoid the sector. Stocks this cheap don't go down because of slowing growth, and no one has a clue as to what 2008 will bring. The homebuilding stocks may not work, no investment outcome is guaranteed, but short of a major decline in the housing industry starting now, nothing should prevent a decent long trade.

So "steel" yourself and pull the trigger on a high-quality homebuilder. Six months from now, assuming my soft-landing scenario for the housing industry occurs, the homebuilder bulls will be galvanized and housing stocks will be much more appreciated. My favorite is Pulte, it's the most defensive name in a typically offensive sector.

Now if we could only get those rock-star homebuilder CEOs like Bob, Bruce, Richard, and Stuart to start buying back stock instead of bidding up land prices...

At the time of publication, Marcin was long PHM, although positions may change at any time.

Robert Marcin is the founder of Defiance Asset Management, a private investment management firm. Client accounts managed by Defiance Asset Management often buy and sell securities that are the subject of commentary by Marcin, both before and after it is posted. Under no circumstances does this column represent a recommendation to buy or sell stocks. This column is intended to provide insight into the financial services industry and is not a solicitation of any kind. Neither Marcin nor Defiance Asset Management can provide investment advice or respond to individual requests for recommendations. However, Marcin appreciates your feedback;

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