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Is now a good time to buy into builders?

Many firms' shares have fallen with the housing market. Some say the sector is ripe for bargain hunters; others say wait.

September 24, 2007|Walter Hamilton | Times Staff Writer

Like other Southern Californians, John Bollinger has witnessed the brutal downturn in the housing market.

But that didn't stop the Manhattan Beach money manager from giving his clients this advice last week: Buy housing stocks.

"If you look back five or six years from now, people will say, 'Wow, those are great stocks to own,' " Bollinger said. "And if you explain to them [the price at which] you bought, people will think you're lying."

It takes guts to recommend shares of home-building companies right now. Not only is housing in the throes of a historic contraction, but most experts also say the deterioration of the market isn't over.

The government reported last week that construction of new homes plunged 19% in August from a year earlier, marking the slowest pace in more than 12 years.

Builders trying to unload inventory are increasingly resorting to gimmicks -- such as New Jersey-based Hovnanian Enterprises Inc.'s "Deal of the Century" sale this month or Irvine-based Standard Pacific Corp.'s "Mission: Possible" promotion.

The carnage in construction stocks has been breathtaking.

Centex Corp. closed Friday at $27.17, down from almost $80 in early 2006. D.R. Horton Inc. has fallen to $14.10 from almost $42. And Lennar Corp. has slumped to $25.32 from more than $66.

Bollinger's buy recommendation is rooted in a long-established stock market dynamic: A company's shares usually recover long before its business or financial results do. By the time a recovery is widely apparent, the best bargains are gone.

"The news is going to remain negative long after the bottom [for the stocks] has been seen," said Paul Desmond, president of Lowry Research Corp., a stock research firm in North Palm Beach, Fla.

How long? Desmond estimates that earnings reports and industry news won't show improvement for six to nine months after a recovery is underway.

So the question is whether an industry rebound will come soon enough to invest in housing stocks now. Many analysts say it's still too early to invest in the industry, arguing that other sectors will do much better in the next couple of years.

The performance of builder stocks last week illustrates how hard it is to identify the time to buy. A Standard & Poor's Corp. index of 16 home builders rose 6% on Tuesday after the Federal Reserve cut its benchmark interest rate.

But it fell 6% two days later and is now lower than before the Fed move.

"Housing stocks are going to be at best a mediocre investment for a long time," said Phil Roth, a market analyst at New York brokerage house Miller Tabak & Co. in New York.

The stocks have been hurt in recent days by a jump in interest rates on long-term Treasury bonds, which influence the rates on fixed-rate mortgages. Although the Fed can control short-term interest rates, the bond market sets yields on long-term Treasuries, which rose after the Fed's rate cut, in part because of fears that it would fan inflation.

Beyond that, many experts say, investors can make money faster in other groups where stocks are rising.

Housing stocks will recover slowly, said Louise Yamada, who heads her own stock research firm in New York, because many investors bought after prices declined only to watch them sag further. They'll anxiously sell on signs of a rebound, damping any rallies, she said.

For example, Yamada said she wouldn't buy Centex shares now even if they started moving up, "because all the disappointed investors who didn't sell at $60 and didn't sell at $40 are going to sell on a bounce."

The near-term outlook, Yamada said, is far better for technology, energy and industrial stocks.

Still, some experts say the worst may be over for housing stocks.

Douglas Kass, head of Seabreeze Partners, a hedge fund in Palm Beach, Fla., made money by selling "short" many housing stocks in the last two years. In a short sale, investors borrow shares and then sell them, betting that they will be able repay the debt by buying the stock at a lower price.

But Kass closed out his short positions this year because he figured the sector wouldn't fall much lower.

"The market has basically discounted the problems," Kass said.

The prices of some stocks in the sector appear cheap relative to the companies' earnings. For D.R. Horton, the ratio of its stock price to its per-share earnings has fallen to 2 today from 12 in early 2004, according to Bloomberg.

And although Kass no longer is betting against the stock, data show that many others have sold it short, which in the contrarian ways of Wall Street can actually be bullish. That's because short sellers must eventually buy the stock to pay back their debt.

The short interest in D.R. Horton -- the number of company shares that have been borrowed, but not yet repaid, by short sellers -- is more than 38 million, up from 29.6 million a month ago and 14.6 million a year ago.

Still, investors must be very patient, cautioned Bollinger, who says an easy way for individual investors to play the sector is through the S&P Homebuilders exchange-traded fund (ticker symbol: XHB).

"I'm not convinced the absolute lows [in the stocks] are in yet," he said, "but I am convinced that owning them at these levels will prove profitable in the long run."

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walter.hamilton@latimes.com

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