Homing In on Housing Winners

Observers say the sector's cooling-off could mean opportunity for stronger performers.
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With housing finally showing some signs of wear, investors are looking for stocks with the least peeling paint.

The once-hot sector has pulled back this month amid worries about consumer spending in the wake of rising interest rates and surging energy costs. Shares in outfits ranging from

Toll Brothers

(TOL) - Get Report


Standard Pacific


have dropped sharply after hitting 52-week highs earlier in the summer.

With the group's broad rally apparently over, observers are trying to figure out which companies can keep delivering impressive results. That means a coming round of quarterly earnings reports will attract close scrutiny -- and that the sector's stronger performers could start to pull away from the laggards.

"We're starting to see it's not this uniform blanket uptrend that we saw a year or so ago," says James Poyner, an analyst with Palladian Research, which doesn't do investment banking. Now the question is, "Are they still beating the numbers and raising guidance or not?"

In the case of


(LEN) - Get Report

, the answer for the time being is yes. The company boosted earnings and home-delivery forecasts Wednesday, pushing its shares 3% higher. Still, with the


having raised rates again just Tuesday, the market's concern remains apparent: Even after Wednesday's rally, the stock is down 10% from last week.

Housing investors will get an eyeful of another key report Thursday morning, when

KB Home

(KBH) - Get Report

is due to post third-quarter earnings.

KB Home, which is generally regarded as one of the better builders, highlights the sector's precarious situation. Even as most homebuilders continue to report solid growth -- even given occasional shortfalls at

Hovnanian Enterprises

(HOV) - Get Report


Beazer Homes

(BZH) - Get Report

-- any disappointment tends to hit shares hard.

Analysts expect KB Home to earn $2.39 a share for the third quarter. That appears doable, but living up to expectations for the fourth quarter and 2006 could be another story. With Wall Street expecting 2006 EPS growth of 19%, even guidance for a solid 15% gain could hammer the stock, J.P. Morgan analyst Michael Rehaut pointed out in a research report Wednesday. He upgraded KB to neutral; J.P. Morgan does investment banking for KB Home.

The KB report will come as investors try to figure out which builders are likely to outperform in a tougher environment. By looking at second-quarter order and backlog growth, Palladian's Poyner came to the conclusion that Lennar, Standard Pacific and Beazer performed the worst.

Pulte Homes

(PHM) - Get Report

, Hovnanian and

D.R. Horton

(DHI) - Get Report

performed the best on this front, he says.

So Poyner expects Pulte,



and perhaps KB Home to outperform in coming months, while Standard Pacific and



could post more disappointing results, he says.