Sell Downgrades Weaken Homebuilder Foundations

NEW YORK (TheStreet) -- The housing market has been a bright spot in a slowly growing economy, but it now seems like this industry has paused. Today I update my profiles for eight homebuilder stocks I have been following, and all have been downgraded, seven now have sell ratings according to www.ValuEngine.com.

In my post on Feb. 21, I wrote Home Builders Hammered by Housing Data where I showed my buy-and-trade strategies for these eight homebuilders. Six of the eight were rated buy despite overvalued valuations and elevated price-to-earnings ratios, hence a recommendation to reduce positions on strength.

Today the construction sector is 23.6% overvalued with the building-residential/commercial industry, which includes the homebuilders 37.1% overvalued. The industry P/E is an elevated 29.5.

This morning we learned that housing starts rose by 0.8% to an annual rate of 917,000 in February with building permits up 4.6% to 946,000. The important single family starts rose 0.5% to 618,000, which continues a trend above the 600,000 threshold that keeps the housing recovery continuing at a modest pace.

On Monday morning we learned that the National Association of Home Builders Housing Market Index slipped to 44 from 46 in March, pausing below the neutral reading of 50. Notice that on the chart below single family starts lag the HMI significantly. The NAHB indicated that the reasons for caution include; "frustrating bottlenecks in the supply chain for developed lots along with rising costs for building materials and labor. At the same time, problems with appraisals and credit availability remain considerable obstacles to completing deals."

The HMI peaked at 72 in June 2005, which is when I predicted a peak of the share prices for the homebuilders.

The index has been below 50 since May 2006, and home prices peaked in June/July of 2006. The low for the index was eight in January 2009.

My benchmark for the homebuilder industry is the PHLX Housing Sector Index ( HGX) (191.18).

It has been moving sideways since Jan. 24 with highs between 192.39 and 194.06. HGX is up 11.6% year-to-date setting its 2013 high on Feb. 13.

My semiannual value level lags at 152.56 with a weekly pivot at 189.82 and monthly risky level at 194.28 lining up the Feb. 13 high.

Chart Courtesy of Thomson/Reuters

Reading the Table

OV/UN Valued: 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: 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: Price at which to enter a GTC limit order to sell on strength.

Notice from the table that the seven sell-rated homebuilders are overvalued by 25.6% to 76.6%. Over the last 12 months these stocks gained between 52.2% and 126.5%, but are projected to decline by 6.5% to 11.3% over the next 12 months.

Given the magnitude of the homebuilder downgrades a prudent investment strategy is to book profits on these stocks as a source of funds.

D R Horton ( DHI) ($24.25 vs. $21.93 on Feb. 21): Downgraded to sell from buy and set a multi-year high at $24.76 on Friday. My semiannual value level is $20.50 with a monthly pivot at $22.89 and weekly risky level at $25.02.

Hovnanian ( HOV) ($5.99 vs. $5.29 on Feb. 21): Downgraded to sell from buy and is well below its Jan. 2 high at $7.43. My weekly value level is $5.35 with a semiannual pivot at $6.00 and monthly risky level at $6.57.

KB Home ( KBH) ($20.42 vs. $18.03 on Feb. 21): Downgraded to sell from hold and set a multi-year high at $20.76 on March 11. My semiannual value level lags at $10.77 with a monthly pivot at $20.69 and weekly risky level at $21.69.

Lennar ( LEN) ($41.58 vs. $37.18 on Feb. 21): Downgraded to sell from buy and set its multi-year high at $43.33 on Jan. 28. My semiannual value level is $36.03 with a weekly pivot at $39.32 and monthly risky level at $42.27.

PulteGroup ( PHM) ($20.75 vs. $18.60 on Feb. 21): Downgraded to sell from buy and set a multi-year high at $21.97 on Jan. 28. My quarterly value level is $13.97 with a weekly pivot at $19.89 and monthly risky level at $23.05.

Ryland Group ( RYL) ($40.73 vs. $34.29 on Feb. 21): Downgraded to sell from buy and set a multi-year high at $43.00 on Jan. 30. My quarterly value level is $28.90 with a monthly pivot at $40.12.

Standard & Pacific ( SPF) ($8.65 vs. $7.54 on Feb. 21): Downgraded to sell from hold and set a multi-year high at $8.95 on March 6. My semiannual value level is $7.36 with a monthly pivot at $8.17 and weekly risky level at $8.68.

Toll Brothers ( TOL) ($34.12 vs. $33.56 on Feb. 21): Downgraded to hold from buy and set a multi-year high at $38.36 on Jan. 29. My annual value level is $31.95 with a weekly pivot at $35.00 and monthly risky level at $36.49.

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.

More from Opinion

7 Takeaways From Google's $550-Million Investment in Alibaba Rival JD.com

7 Takeaways From Google's $550-Million Investment in Alibaba Rival JD.com

It's Just Not Smart For Investors to Ignore the Threat of a Trade War

It's Just Not Smart For Investors to Ignore the Threat of a Trade War

To Think a Trade War's Still Just a Threat Is the Dumbest Thing on Wall Street

To Think a Trade War's Still Just a Threat Is the Dumbest Thing on Wall Street

Flashback Friday in Politics: Trade Wars, Manafort, Immigration Dominate Minds

Flashback Friday in Politics: Trade Wars, Manafort, Immigration Dominate Minds

Microsoft and Sony's Rumored Game Console Plans Bode Well for AMD

Microsoft and Sony's Rumored Game Console Plans Bode Well for AMD