The homebuilding sector will post flat earnings growth in 2006 and 2007, and that means investors should focus on larger builders with established share-buyback programs and positive free cash flow, according to research reports released Monday morning by Wachovia. Analyst Carl Reichardt upgraded Toll Brothers ( TOL) to buy from hold, noting that he believes the worst news is behind the company and that the stock represents a compelling valuation. Reichardt values Toll at $40 to $43, representing 8 to 8.5 times his estimate for 2007 EPS of $5.05. Analysts' average forecast is for 2007 earnings of $4.75 a share, according to Thomson First Call. Toll shares rose $1.47, or 4.3%, to $35.82 Monday morning. Even though he expects Toll's order comparisons to remain challenging in the short term, Reichardt anticipates the comparisons will get easier after the second quarter. He also believes a rebounding Washington, D.C., market (which represents about 15% of Toll's current community count) will help the luxury-home builder. Reichardt also downgraded three smaller builders because the companies have negative free cash flow and no major commitments to share repurchases. He cut Standard Pacific ( SPF) to hold from buy, downgraded M.D.C. Holdings ( MDC) to sell from buy, and cut Orleans Homebuilders ( OHB) to sell from hold. "We still believe the large public builders have the ability to gain market share relative to their smaller brethren, even as headroom shrinks," Reichardt wrote in his report. "At 6.7x our new (2007 estimated EPS), we still believe the companies are inexpensive relative to the market, discounting some level of broad market slowdown. "However, as the cyclical slowdown unfolds we believe a secular change will emerge. As such, we are focused on the large players with sustainable advantages over mid-tiers, and builders with shareholder friendly capital management philosophies." The companies' shares were little moved on the report. MDC shares were down 8 cents to $66.80, Orleans shed 13 cents to $19.85, and Standard Pacific rose 15 cents to $35.16.