Homebuilder Stocks a Sucker’s Bet

The stock market is a funny beast. At times, its trends make perfect sense. Other times, its moves leave you with nothing to do but shake and scratch your head.

Right now, homebuilder stocks are the big enigma.

The housing market, despite a dead cat bounce from a dismally low bottom, is still moribund. New home starts in January dropped by 8.5%, to an annual rate of just 890,000 units. This level of activity is about one-third as strong as the 2.3 million starts we saw at the market’s 2006 peak, and just half as strong as pre-bubble activity of 1.7 million units in 2000.

This is not the start of a vivacious trend for homebuilders. But they may not care – their stock prices are up between 49% and 137% over the last 12 months. Take a look at the epic rise of PulteGroup’s (PHM) stock price, which has led the pack…:

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This rapid appreciation of homebuilder stocks is so perplexing because stock prices reflect investors’ collective assessment of the company’s future earnrnings. This discounted cash flow model involves projecting how much a company is expected to earnrn (net income) next quarter or next year, then discounting that income stream to its present value.

The rub is, homebuilders haven’t made money in years. PulteGroup’s cumulative net income since 2007 is a negative $6 billion. KB Home (KBH) has lost money every single year since 2007, losing $2.3 billion in total – or 144% of its entire market cap!

So how investors are able to accurately project future profitability, which is absolutely necessary to determine a fair value stock price, is beyond me! I don’t think they are. I think the run up in homebuilders stocks is nothing but wishful thinking.

Investors are setting themselves up for a big disappointment when it becomes obvious that the property market will never, ever be what it used to be.

Stay tuned.

Adam O’Dell

Using his perfect blend of technical and fundamental analysis, Adam uncovers investment opportunities that return the maximum profit with minimum risk.