The Real Story: Digging for Value in Beazer

The homebuilder gets hurt by its weak guidance, but remains a growth story and a good value.
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What have you done for me lately?

-- Janet Jackson

Investors can be a nasty bunch and have expectations that are even shorter-term than those of Ms. Jackson. For the most part, they're not as concerned with what's been done lately as they are with what will happen tomorrow.

On Thursday,

Beazer Homes

(BZH) - Get Report

reported strong fiscal second-quarter numbers. The homebuilder earned $2.35 per share on revenue of $1.27 billion, beating the consensus estimate of $2.27 and $1.17 billion.

But the stock was sold hard Thursday after Beazer said it experienced a 19% decline in new orders and lowered its full-year EPS guidance to $10-$10.50. The previous consensus was $10.48. If Beazer is able to deliver even the low end of that range, it would still represent 15% earnings growth over last year.

The good news was that the operating margin increased, the average sales price jumped nearly 10% and the average sales price in backlog was above $300,000 for the first time in the company's history. But those figures couldn't offset the decline in orders and the fears that earnings estimates have more room to drop. In recently trading, Beazer was down 3% to $57.23.

When it comes to Beazer and many of the other homebuilders, like

Centex

(CTX)

,

KB Home

(KBH) - Get Report

and

Ryland Group

(RYL)

, the important question is are investors more concerned with the P (price) or the E (earnings)?

TheStreet.com's

Nicholas Yulico

wrote an excellent piece about homebuilder stocks possibly becoming value traps as earnings could be headed below expectations.

Brad Ruderman of Ruderman Capital Management, who was bullish on Beazer in my

original story on the firm, says the market doesn't believe the guidance that management provided. Homebuilders "are going to trade with a haircut until management can show consistency in their guidance," he says.

Investors will want to wait and see that management has a handle on its business before deciding how to value the company. When that occurs, Ruderman, who is long Beazer, expects prices to be higher. "I'm not suggesting that these companies deserve a premium," he says. "But history tells us that eight to 10 times earnings is probably a doable number."

In Beazer's case, the average forward P/E over the past 10 years is 7.3. Even if you suspect management is off by more than 20% and the company will earn only $8 in 2006, the stock is fairly priced at current levels based on that historical average.

Earnings of $9 suggest a price of over $65, and if the company comes in even at the low end of guidance, you're looking at a price of over $70 based on its historic P/E. So it looks to me like more bad news is already priced in.

The stock is also trading at a discount to its peers. Beazer is trading 10% below the average of the homebuilding group based on a forward P/E basis over the next three years, according to Thomson Financial.

With the latest fall in share price, it is likely that many of the momentum players have been shaken out. Deep-value investors, such as Legg Mason, have taken an increasing interest in the stock.

In addition, Ruderman believes that some aggressive activist investors may find Beazer appealing and persuade the company to get more aggressive with its stock buyback plan. "I think that's a decent combination, but not a combination for instant gratification," he cautions.

With so much bad news in the sector, it's tough not to panic. But for long-term investors who are willing to ride out the storm, Beazer remains a growth story and a good value.

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

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86,87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

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