When homebuilders report earnings, as several are doing this week, they may sound cautious about their future outlook. In doing so, they'd be joining a growing trend on Wall Street this earnings season. But in their case, at least, the market shouldn't necessarily believe them.

The CEOs of the big U.S. homebuilders aren't like other CEOs. In fact, they are probably hoping that the market they operate in continues to cool down.

The reasons are both obvious and not so obvious. On the one hand, a cooling housing market is one of the keys to allowing the

Federal Reserve

to stop tightening sooner vs. later. This, of course, would help keep mortgage rates relatively low and demand for homes strong in the long run.

On the other hand, ever since the housing market began to show signs of cooling last year, homebuilders have learned the hard way that disappointing results may be punished more than strong results might be rewarded.

As signs of a cooler market became evident last summer, the homebuilding sector, as measured by the Philadelphia Stock Exchange Housing Sector Index, initially collapsed 20% from a July 28 high of 586.06 to an Oct. 18 low of 473.32.

Profits had stayed strong throughout the period and 2005 still showed a record year for home sales. But amid the doomsday scenarios about a housing bubble, "some of these stocks have tended to fall 15% on bad news, and not gain much on good news," says Arthur Oduma, housing sector analyst at Morningstar. As a result, homebuilders have been guiding earnings downward and are careful to "not try to sound too bullish about the future, as they'd rather surprise on the upside."

That's what happened with

Centex

(CTX)

, which reported better-than-expected earnings after the close of trading Tuesday. Centex also confirmed its existing 2006 and 2007 earnings forecasts. Its shares, which had dropped 0.2% in regular trading, recently rose 1.1% in after-hours trading.

Earlier Tuesday, strong earnings from

United Technologies

and a drop in crude oil prices, also propped up the major averages. The

Dow Jones Industrial Average

gained 49.54 points, or 0.46%, to 10,738.31. The

S&P 500

rose 6.44 points, or 0.51%, to 1270.26, and the

Nasdaq Composite

advanced 19.64 points, or 0.87%, to 2268.11.

Checking the Foundation

Homebuilding stars

KB Home

(KBH) - Get Report

and

Lennar

(LEN) - Get Report

were among the first to start turning cautious about the housing market, even if they've remained more vague about their own prospects.

It could be argued that the market had already caught up to the game in the last two months of 2005 and through early January. From its October low, the housing index had rebounded 18.4% to a Jan. 11 high of 560. But it has since fallen back more than 5% along with broader market declines amid disappointing earnings guidance from several high-profile companies.

Even if the housing market continues to slow, however, the prospects remain good for many of the big homebuilders, as shown by their rising backlog of orders, according to Oduma.

Most importantly, the big homebuilders are pretty much at the opposite pole from most homebuyers. Most are not locked into land-owning contracts, nor are they very leveraged, as the huge gains in their share prices has made financing easy.

Ryland

(RYL)

, which was scheduled to report earnings after the close, has the clearest advantage on both of these counts. Three-quarters of Ryland's land is owned through option contracts, which allow it to control land for three to four years for a 5% to 10% deposit. In case of a housing slowdown, it can surrender control and doesn't have to add losing assets on its balance sheet.

Hovnanian

(HOV) - Get Report

and

MDC Holdings

(MDC) - Get Report

are also particularly well hedged through options contract. These builders are therefore very well protected against downturns in regional markets.

Of course, not all homebuilders are equally hedged.

DR Horton

(DHI) - Get Report

and

Pulte Home

(PHM) - Get Report

, for instance, own close to 50% of the land where they operate, putting their balance sheets more at risk in case of a downturn.

Others are more exposed to downturns in "frothy" markets, mostly in the coastal areas where prices had been rising nonstop over the past three years. These include

Levitt

( LEV), which has most of its assets in Florida;

NVR

(NVR) - Get Report

, which has nearly 50% of assets in Virginia and Maryland; and MDC, which is mostly in California, Arizona and Nevada.

At the same time, homebuilders are no more protected than other industries from higher input prices. The rising cost of materials and of construction labor could pinch profits more than a cooling housing market, especially with large governmental plans to rebuild the hurricane-ravaged Gulf Coast.

Still, the big homebuilders can absorb the pinch better than the little guys. "That's another reason

public homebuilders CEOs are preying for a cooling down in the market," says Oduma. "The smaller guys will be forced out, and they will have to sell land to the big guys" at cheaper prices.

If the market has truly caught up to the game, homebuilding shares may therefore rise on Wednesday, even as the National Association of Realtors is expected to announce that existing-home sales have declined to 6.89 million in December, from 6.97 million in November, marking the third monthly decline in a row.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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