Homebuilders' Valuations Are Extremely Speculative

NEW YORK (TheStreet) -- The housing market has become overvalued fundamentally and overbought technically after astronomical gains since October 2011 and year to date. The construction sector is 8.4% overvalued according to www.ValuEngine.com and my benchmark for the sector, the PHLX Housing Sector Index (HGX), is extremely overbought on its weekly chart, and has been overbought since the week of Aug. 10. The HGX is up a whopping 113.8% since Oct. 2011, and up 52.9% year to date.

I have been tracking the homebuilder stocks since 2005 when I predicted the housing bubble and recommended booking profits on the homebuilders. On June 21, 2005, I wrote this for Realmoney.com, "Homebuilders' Charts Testing Hearts," and included the table of levels shown below.

The takeaway from the table is that all of the homebuilders listed were overvalued by 3.8% for DR Horton to 25.1% for KB Homes back on June 17, 2005. Today the Buy rated homebuilders are 2.9% to 62.0% overvalued. In terms of P/E ratios back in 2005 the range was between 9.1 and 15.1 times forward estimates compare to today's range of 30.2 to 149.1 times. Back in 2005 I described those P/E ratios has high by historical measures. These statistics are reason enough to book profits on homebuilder stocks and for investors to avoid the group for now.

Recent data on the housing market continue to show slow and steady improvements in the market for new homes.

Homebuilder Confidence Rose Again in September

The National Association of Home Builders reported that their Housing Market Index rose to a reading of 40 in September, a rise of three points from August, the fifth consecutive month of improvement.

Even so, the Housing Market Index remains 10 points below the neutral reading of 50, and the NAHB described the release as "still having a long way to go on the road to recovery as several obstacles are slowing our progress." The major concern remains "that unnecessary tight credit conditions are preventing many builders from putting crews back to work."

Chart Courtesy of NAHB/Wells Fargo Housing Market Index

It seems to me that record low inventories of new homes is discouraging prospective new home buyers from becoming actual new home buyers. The NAHB indicated that in some markets there is a lack of building lots and the cost of building materials is on the rise.

The bottom line is that the market for new homes is less depressed that it had been for the prior five months. The graph above shows that builder sentiment is leading new single-family starts.

Housing Starts Rose 2.3% in August: Strength in single-family starts boosted the overall number. Single-family starts rose to a seasonally adjusted annual rate of 750,000 units. The important single-family sector saw new construction up 5.5% with a gain of 535,000 units. The NAHB reacted to this improving trend with the note that "there is still plenty of room for improvement."

New Home Sales for August: These came in at an annual rate of 373,000 units, which was below analysts' estimates. The inventory of new homes remains near a record low at 141,000 units.

The S&P/Case-Shiller Home Price Indices: I focus on the 20-City Composite and this index was up 1.6% in July versus June 2012, up 1.2% year over year and up 7.8% since the recent low. Home prices are still down 30% from the June / July 2006 housing market bubble peak.

Chart Courtesy of S&P Dow Jones Indices and Fiserv

Here I profile nine of the stocks in the PHLX Housing Market Index. Despite this positive data for the homebuilders I continue to be cautious about the sustainability of the powerful rally in this industry.

Chart Courtesy of Thomson/Reuters

The weekly chart for PHLX Housing Sector Index (157.44) shown above shows extremely overbought momentum with the index well above its five-week modified moving average at 151.97. The multi-year high was set on Sept. 21 at 168.79. This high was well above 145.52, which is the 38.2% Fibonacci Retracement of the entire down trend from the July 2005 high to the March 2009 low.

This level now becomes support on the downside. The 50% retracement at 173.81 is resistance to the upside. My quarterly and annual value levels are 135.17 and 122.53 with a monthly pivot at 158.52, which was tested on Wednesday's downside.

The above table shows data from www.ValuEngine.com covering eleven stocks in the BKX.

Reading the Table

OV / UN Valued: The stocks with a red number are undervalued by this percentage. Those with a black number are overvalued by that percentage according to ValuEngine.

VE Rating: A "1-Engine" rating is a strong sell, a "2-Engine" rating is a sell, a "3-Engine" rating is a hold, a "4-Engine" rating is a buy and a "5-Engine" rating is a strong buy.

Last 12-Month Return (%): Stocks with a red number declined by that percentage over the last 12 months. Stocks with a black number increased by that percentage.

Forecast 1-Year Return: Stocks with a red number are projected to decline by that percentage over the next 12 months. Stocks with a black number in the table are projected to move higher by that percentage over the next 12 months.

Value Level: is the price at which to enter a GTC Limit Order to buy on weakness. The letters mean; W-Weekly, M-Monthly, Q-Quarterly, S-Semiannual and A- Annual.

Pivot: A level between a value level and risky level that should be a magnet during the time frame noted.

Risky Level: is the price at which to enter a GTC Limit Order to sell on strength.

Beazer Homes ( BZH) ($3.50): Has a sell rating according to ValuEngine, without a calculated P/E ratio. BZH is above its 200-day SMA at $2.96. Investors should avoid this homebuilder and traders should employ a "buy and trade" strategy between the value level and risky level.

D R Horton ( DHI) ($20.90): Has a buy rating according to ValuEngine, an elevated P/E ratio and is above its 200-day SMA at $16.24. Book profits and employ a "buy and trade" strategy between the value level and risky level.

Hovnanian ( HOV) ($3.43): Has a sell rating according to ValuEngine, without a calculated P/E ratio. HOV is above its 200-day SMA at $2.44. Investors should avoid this homebuilder and traders should employ a "buy and trade" strategy between the value level and risky level.

KB Home ( KBH) ($13.90): Has a hold rating according to ValuEngine, without a calculated P/E ratio. KBH is above its 200-day SMA at $9.56. Investors should avoid this homebuilder and traders should employ a "buy and trade" strategy between the value level and risky level.

Lennar Corp ( LEN) ($34.64): Has a buy rating according to ValuEngine, an extremely elevated P/E ratio and is above its 200-day SMA at $26.93. Book profits then employ a "buy and trade" strategy between the value level and risky level.

Pulte Group ( PHM) ($15.30): Has a Buy rating according to ValuEngine, has an extremely elevated P/E ratio and is above its 200-day SMA at $9.82. Book profits then employ a "buy and trade" strategy between the value level and risky level. I show an annual risky level at $26.56.

Ryland Group ( RYL) ($30.01): Has a buy rating according to ValuEngine, has a ludicrous reasonable P/E ratio and is above its 200-day SMA at $21.78. Book profits then employ a "buy and trade" strategy between the value level and risky level.

Standard & Pacific ( SPF) ($6.80): Has a buy rating according to ValuEngine, has an extremely elevated P/E ratio and is above its 200-day SMA at $5.10. Book profits then employ a "buy and trade" strategy between the value level and risky level.

Toll Brothers ( TOL) ($34.16): Has a buy rating according to ValuEngine, has a Ludicrous P/E ratio and is above its 200-day SMA at $26.33. Book profits then employ a "buy and trade" strategy between the value level and risky level.

The six buy-rated homebuilders are overvalued with Lennar the most overvalued by 62.0%. The three hold and sell rated stocks are undervalued with Beazer the most undervalued by 62.4%. All nine homebuilders had unbelievably strong stock performances over the past twelve months with tremendous triple digit gains led by Pulte with a gain of 272.3%.

The projected performances for the next 12 months range from a loss of 7.7% for Beazer to a 9.4% gain for Toll Brothers. Given these potential single digit losses and gains investors should book profits and avoid the group. Traders keep on trading but beware of the downside risk.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. In 1981 he formed the Government Bond Department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008 producing newsletters covering the U.S. capital markets, and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy and can be reached at RSuttmeier@Gmail.com.

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