This Housing Recovery Is Real

NEW YORK ( TheStreet) -- The stock of Miami-based Lennar ( LEN) is up 168.3% over the last 12 months. The stock of Ft. Worth, Texas-based DR Horton ( DHI) is up 133% over the last year. How about Atlanta, Ga.-based Home Depot ( HD)? Its stock is up 87.1% over the last 12 months. By comparison, the S&P 500 is up 26% during the same period of time.

This is my current ranking of the various sectors of the market that I track on a daily basis; the good and the bad:

Data from Best Stocks Now app

Biotech, with its A-, is followed by housing, with a B+. As of now, I remain heavily invested in the biotech sector. It has been at the top of the rankings almost since the beginning of the year. I took a 62% profit in Pharmacyclics ( PCYC) and a 64% profit in Alexion Pharmaceuticals ( ALXN) earlier this year. I am back in both of those stocks right now, along with several other biotech-related stocks.

I own them in the aggressive growth accounts I manage. As of Friday, this portfolio of 25 stocks was up just over 20% year to date. To see the whole portfolio, you can get four free copies of my weekly newsletter by clicking here.

As mentioned above, the U.S. home construction sector is ranked No. 2. I use the exchange-traded fund iShares Dow Jones U.S. Home Construction ETF ( ITB) as a proxy for this sector. Let's take a quick look at its performance over the years:

Data from Best Stocks Now app

As you can see, the five-year performance of the overall housing sector has just about matched the return of the S&P 500. Over the last three years, however, the sector has delivered about eight points of alpha per year over the market. This sector has really roared over the last 12 months, with a return of 119.7%.

You can also see from the one-year chart of ITB below, just how strong this sector has been:

Is this rebound in the housing market for real?

I was asking myself this same question several weeks ago, when decided to invite Mick Pattinson back on my daily radio show, Best Stock Now.

The last time I had Pattinson on, which was about one year prior, he sounded so glum that I was about to call the prevention hotline to locate folks who talk people down off of bridges. At that time, Pattinson painted such a bleak picture of the housing market, I was not sure we would see a recovery in housing in my lifetime.

That was then, this is now. I trust Pattinson's opinion of the all-important housing market. After all, not only is he the CEO of Barratt Group in California, he is the former head of the Builder's Industry Association there. Pattinson has seen numerous cycles in California, which I consider to be the epicenter of the single-family home market.

I do not see new lots being cut into the hillsides of sunny, Southern California. I do not see truckloads of lumber headed for the new housing tracts. Nor do I hear construction workers celebrating about all the work they have. I fully expected his answer to be negative. My whole interview to follow was based on that assumption.

Instead he said responded, "Yes, Bill, it is for real!" I thought that he was going to proceed by telling me that there was also a Santa Claus!

He then went on to tell me about the wait time to get an appraisal. He told me about the shortage of workers in some markets, and he also reminded me of that very important factor in the housing market: Supply and demand.

The homebuilders have not done a lot of building of new homes over the last five years. In addition to this, the so-called shadow inventory of foreclosures is disappearing fast with the voracious appetite of investors looking to buy and turn them into rental units.

In addition to this, money is still cheaper than the dirt on which homes are built. With 30-year mortgages hovering around 3.5% and the banks starting to loosen up a bit, there are buyers once again. I was also told by my mortgage expert, Craig Brock, that his company was holding a big job fair in order to get enough loan processors right now!

Now let's take a look at the performance of Lennar's stock over the years:

Data from Best Stocks Now app

As you can see, the stock has performed in line with the S&P 500 over the last 10 years. Over the last five years, it has surprisingly beaten the market quite handily. Over the last three years, the stock has sizzled at a rate of 38.9% per year. The stock has exploded over the last 12 months for a 168.3% gain.

This huge gain in the stock begs the question: "Have the homebuilders gotten expensive, from a valuation point of view?"

Let's take a look at the current valuation numbers on Lennar:

Data from Best Stocks Now app

Lennar's stock is currently trading at 23 times forward earnings. The consensus analysts' forward growth rate is 6% per year. This makes for a very high PEG ratio.

It is obvious that investors are looking down the road for those earnings at Lennar to really start to ramp up. For new investors, I believe the stock is a bit ahead of itself from a valuation perspective. However, I don't believe current investors should unload their shares.

I like to buy stocks that combine performance with value. Lennar has the performance (momentum) right now, but it is hard to justify a new buy in the stock at the current valuation.

Let's take a look at another stock, tied to this sector, that does combine performance and valuation right now.

We will go to Bloomington, Minn. and pay a visit to Toro ( TTC). Most of you are familiar with its products. I have had my share of experience with accidentally cutting a PVC line under pressure and getting my face water-blasted. It is so embarrassing!

After several trips of returning the wrong part to the local Home Depot, you finally have the connection that you need. Wait a minute; one more trip to Home Depot to get a can of that blue glue that gets all over your skin and takes days to peel off. Several hours later, you are ready to tell your wife that she can turn on the water to the house after an all-day drought.

Well, so much for the ruined Saturday, but what about the stock of Toro? Let's first look at its performance:

Data from Best Stocks Now app

As you can see, the stock has been a great performer over the years. In fact, when I compare it against the other 3,000 or so stocks I follow, it earns a performance grade of A-.

What about value?

Data from Best Stocks Now app

The valuation is quite reasonable, with a forward PE ratio of 16.8 and a PEG ratio of 1.12. I love combining performance with value. The chart of the stock is also quite good. I am currently long Toro and Home Depot. I also have an exit plan on a both stocks, if things should change.

The bottom line: The rebound in housing is for real and it is in the very early stages. This is great news for real estate agents, appraisers, mortgage loan folks, investors in real estate and for investors in the housing-related stocks!

At the time of publication, Gunderson was long PCYC, ALXN, HD and TTC although positions may change at any time.

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