4 Stock Picks for an Increasingly Upbeat Housing Market

Confidence is building around the housing market. Homebuilder optimism is matching its highest level in a decade. The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) surged in September to 65, matching October 2015's reading. Before last October, the index had last hit 65 before the financial crisis. Today we'll look at four stocks that will benefit from housing market strength.

First, however, let's review in more detail the significance of the NAHB/Wells Fargo index. Once a month, the NAHB surveys its members on current housing market conditions and their outlook for the housing market going forward, and it compiles these results into the HMI. The survey has been conducted for more than 30 years and, according to information posted on the NAHB website, it gauges builder perceptions of current single-family home sales and sales expectations for the next six months as "good," fair" or "poor." Homebuilders formulate their responses using their observations of buyer foot traffic as well as actual sales in their day-to-day businesses.

U.S. housing starts fell more than expected in August, but this Reuters article attributed the dip to bad weather that disrupted activity in the South and also noted that groundbreaking activity had been "running well ahead of permits approvals over the past several months."

"With the inventory of new and existing homes remaining tight, builders are confident that if they can build more homes they can sell them," said Robert Dietz, the chief economist at NAHB. 

Here are four homebuilder stocks that score highly using our guru stock screening models:

1. LGI Homes (LGIH)

This company is engaged in the design, construction, marketing and sale of new homes. The company earns a perfect score under our James O'Shaughnessy-based stock screening model due to its consistent growth of earnings per share over the past five years and its price-to-sales ratio of 1.05. (In order to pass this screen, a stock must have a price-to-sales ratio of less than 1.5.) Our Validea Momentum model also likes LGI Homes because of its quarter-over-quarter EPS growth of 45.45% (vs. the minimum requirement of 18%) and annual EPS growth of 81.68% (well in excess of the 25% preferred minimum). Our Martin Zweig-based strategy gives a thumbs-up to LGI Home's revenue growth (94.39%) as it exceeds EPS growth of 81.68% and indicates that the company's EPS growth is supported by the top line.

2. NVR (NVR)

NVR is engaged in the construction and sale of single-family detached homes, townhouses and condominium buildings. Under our Peter Lynch-based investment model, NVR shows well given its strong price/earnings-to-growth (or PEG) ratio, an earmark of the Lynch philosophy, which evaluates fairness of price by measuring the price-to-earnings ratio as a percentage of EPS growth. With a PEG ratio of 0.51, NVR passes this test (requirement of below 1.0). NVR earns a perfect score under our O'Shaughnessy model due to its size (market cap of $6.38 billion), consistent growth in earnings per share over the last five years, and its price-to-sales ratio of 1.16 (below the 1.5 max).

3. D.R. Horton  (DHI)

D.R. Horton is engaged in the acquisition and development of land and the construction and sale of residential homes. The company scores well under our Lynch-based screen given its favorable PEG ratio of 0.46. The company's inventory-to-sales ratio is considered favorable at 72.13%, particularly since it represents a decrease from the previous year. (If inventories increase faster than sales, they create a red flag under this model).

4. AV Homes  (AVHI)

AV Homes is engaged in homebuilding and community development in Florida, Arizona and the Carolinas. While this is a small-cap stock and therefore could display more volatility than the broader market, the company earns a perfect score under our O'Shaughnessy-based model due to its persistent EPS growth over the last five years as well as its favorable price-to-sales ratio of 0.54 (required to be under 1.5 under this model).

This article is commentary by an independent contributor. At the time of publication, the author held shares of LGIH. 

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