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Pulte vs KB Home: Analyst's Toolkit

Both homebuilders are producing losses, and their shares have fallen through the floor. But a side-by-side comparison shows they haven't been created equally.

BOSTON (

TheStreet

) --

Pulte Homes

(PHM) - Get Report

and

KB Home

(KBH) - Get Report

shares jumped yesterday after a report said existing-home sales rose to the highest level in almost three years.

The latest gauge of property sales is promising because it shows there are buyers willing to invest in the depressed housing market. The correlation to Pulte and KB Home, however, seems spurious because those companies build new homes. New-home sales for November, released today, totaled 355,000, 11% less than in October and lagging behind economists' estimates of 438,000. While consumers are willing to take advantage of the tax credit for existing homes, new homes are too rich for their blood. KB Home and Pulte shares also rose today.

Still, there may be a reason to bid up homebuilder shares. Comparing Pulte and KB Home based on financial metrics can help determine if there is a hidden value.

Price-to-Sales Ratio

KB Home: 0.48 Pulte: 0.63

While the price-to-earnings ratio is a common way to compare similar companies, the two builders are producing losses, rendering the P/E ratio useless. KB Home has a more attractive price-to-sales ratio. But investors should be primarily concerned with the amount of money that finds its way to the bottom line.

Return on Equity

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KB Home: -72.8% Pulte: -41.2%

Those are the type of figures that usually send investors running for safety. Negative returns on equity in the high double digits suggest the companies are running through the equity portion of the balance sheet and straining finances. While Pulte isn't losing as much as KB Home, both need to become profitable in a hurry to maintain the company's ability to repay debtors.

Beta

KB Home: 1.75 Pulte: 1.65

Such high betas underscore the fact that these investments aren't for the timid. Their stock-price charts resemble a picture of a rollercoaster, with steep climbs and big drops. For those looking to preserve capital, look elsewhere. These homebuilders are far from a sure thing, and the frequent ups and downs will cause more anxiety than any reward could justify.

Weighted Average Cost of Capital

KB Home: 11.14% Pulte: 10.84%

Because both companies carry a weighty debt load, the riskiness of their equity doesn't show up well in their weighted average cost of capital. Breaking down the WACC into its components, we see that the equity portion of the figure costs the companies more than 14%, well in excess of the market's expected return of 10%. That means investors are expecting to be compensated handsomely for risking their cash with these builders. Based on analysts' estimates, that's not likely to happen. Both companies are expected to lose money again in 2010.

Free Cash Flow

KB Home: $136.7 million Pulte: -$1,386.3 million

Here's the real difference between the builders. While KB Home has managed to stay cash-flow positive in the past 12 months, despite weak sales and net losses, Pulte has plummeted to a huge negative free cash flow figure of nearly $1.4 billion on the massive repayment of debt. The company is whittling away at its cash position due to the extinguishment of debt.

As a huge amount of debt was retired, Pulte actually increased its leverage with the acquisition of Centex Corp. So, the company is remaining highly leveraged even though its free cash flow has fallen through the floor.

These stocks are too murky. While KB Home has promising cash flow, it's still tied to the housing market, which could move in a lot of wacky ways next year as the tax credits expire and mortgage rates rise. Pulte is also riddled with problems. Even though the two companies' shares can pop on strong housing numbers, there still isn't enough to justify an investment. The companies are for speculators.

-- Reported by David MacDougall in Boston.

Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.