Contrarian investors know what Albert Brooks' character ultimately learned in
Defending Your Life
: To succeed, you need to stare down your fears. In the stock market, that means keeping the faith in your investing thesis -- even (or especially) when everyone else says you're wrong.
Which brings us to today's subject: homebuilders. There's a lot of fear regarding the sector, but a bullish contrarian case can be made for the group, and
The Consensus Story
Interest rates are rising, making mortgages more expensive. That can particularly affect first-time buyers -- an important Beazer customer. Housing inventories are up, new-home sales hit their lowest level since 2003 in February, and, generally, the previously white-hot housing market is cooling; that will result in slower earnings growth for homebuilders.
The Real Story
Contrarians believe bad news is likely priced into Beazer (and most of the other homebuilders); as a result, value investors are picking up shares. The technical picture is sound and the stock is very heavily shorted, making it ripe for a short squeeze.
What makes Beazer attractive from a contrarian point of view is that the media is ringing the death knell of the real estate market. As I type this,
is running a segment on the riskiest markets. But it's not only the media sounding the alarm bells.
According to the
PMI Mortgage Insurance's
( PMI) U.S. Market Risk Index, 48 of the nation's 50 largest metropolitan areas face a greater risk of declining home prices this quarter vs. last. PMI anticipates a gradual cooling of the housing market as opposed to a crash.
So why on earth would an investor consider Beazer or any homebuilder?
Regarding homebuilders, "public equity markets have already factored in what could only be described as a macro disaster," says Brad Ruderman of Ruderman Capital Management in Beverly Hills, Calif.
Ruderman, who is long Beazer, believes the bad news is already priced into the stocks and that "
policy is so telegraphed, markets have ample time to adjust."
He also likes the fact that the company is committed to returning capital to shareholders. Beazer announced a 10 million-share buyback program in November. However, with just $12 million in cash on its books as of the end of the year and negative cash flow, Beazer will need to borrow the funds in order to complete the share repurchase.
Ruderman isn't dissuaded. "If you could borrow money at favorable rates and buy back stock at a favorable multiple, you'll clearly increase your
return on equity, which hopefully would lead to a higher stock price in the not-too-distant future," he says.
Some big value players seem to agree. Legg Mason, the second-largest institutional holder of Beazer, bought 4.5 million shares (11% of the outstanding shares) in the fourth quarter, according to Thomson Financial, including 2.5 million by legendary value investor Bill Miller's
Legg Mason Value Trust.
Overall, Legg Mason is bullish on the homebuilder sector: In the fourth quarter, three of the firm's five-largest purchases were
, according to Thomson.
Beazer insiders have been hanging onto their shares as well. In the past six months, the only sizable sale has been from COO Michael Furlow, who parted with 180,000 shares. CEO Ian McCarthy and CFO James O'Leary have been acquiring shares through stock grants. The CEO has nearly 800,000 shares, or 2% of the outstanding. His last sale was in August 2004, when the stock was above $90.
Meanwhile, the stock is loved (or should I say hated) by shorts: 22%, or nearly 9 million shares, are sold short. That's down from its peak in January when nearly 12 million shares, or 29% of the float, was short, but it is still significant. A short squeeze is always possible.
With homebuilders, including Beazer, trading with a forward price-to-earnings ratio of 6, they are near the bottom of their historical valuations of between about 5 times and 10 times forward earnings. If Beazer can increase its multiple to just 7, that would add nearly $11 to its market cap.
Any hint the Fed is finished raising or that housing is no longer declining could be the catalyst for such multiple expansion, however modest. Ruderman also believes the group could mirror the steel sector, which caught fire when
made its takeover bid for
. The sector, which jumped 40% in the first quarter, got another lift when it became apparent that economic headwinds were not emerging as feared. He believes the same thing could happen in the homebuilder sector.
Beazer, along with peers
, have shown financial discipline by not purchasing too much land or overbuilding during the downturn, according to Ruderman. He believes that's an important distinction between this and other down cycles in housing, when homebuilders overbuilt and overbought.
That said, I'm not bullish on all homebuilders and real estate plays.
For example, I recently wrote a
bearish story on
, due to what I believe will be a tough market to sell (northwest Florida) in a market downturn. In St. Joe's case, I don't believe bad news is priced into the stock, as in the case of Beazer and some other homebuilders.
Beazer is near the bottom of a rising channel, suggesting the downside risk is limited while there is significant room for upside. Additionally, after falling below its 200-day moving average in early March, the stock rebounded and is now sitting on the average -- just above $64 -- which should act as support.
The group looks healthy as well. The chart of the Philadelphia Housing Index shows a current uptrend. "Most people are looking for the sector to deteriorate because it will validate their fundamental thesis, but technically, it looks pretty stable," says John Roque, technical analyst with Natexis Bleichroeder.
With a break below 250 on the index, Beazer shares may have some difficulty maintaining their own bullish pattern. But as long as the trend holds, Beazer should continue to gradually make its way higher.
One last item to think about. While booms and busts are exciting and headline-grabbing, they don't occur that frequently. We're still shaking off the effects of the dot-com boom and probably will be for years. However, most markets, even very strong ones, tend to gradually go lower when they enter a bearish phase. I'm not enough of a real estate maven to know whether housing will collapse, continue to slip, stagnate or rebound. But with other smart investors already on board, lots of shorts and low valuation, it's time to conquer those fears.
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;
to send him an email.