The next year looks bleak for homebuilders’ coffers…
In 2023, Wall Street analysts expect 20 of the 24 publicly traded homebuilders we track to see earnings declines. That’s more than 80% of the group.
It’s a stark contrast to Wall Street’s expectations for business in general…
Analysts forecast lower earnings for just 21% of S&P 500 companies. And they expect the same thing for only 20% of the more than 5,300 companies tracked in the Power Gauge.
Despite that discrepancy, the Power Gauge is optimistic on many homebuilder stocks…
The system ranks 12 companies in the space as “bullish” or better today. Another 10 companies rank as “neutral.” And only two companies are “bearish” or worse.
Even better, many homebuilder stocks are outperforming the broad market…
The median share-price gain for this industry over the past month is about 13%. That’s much better than the roughly 5% median for S&P 500 companies and the approximately 2% for all the rated stocks in the Power Gauge.
So in other words…
Wall Street expects homebuilders’ earnings to fall in 2023, but it’s still buying their stocks.
That might seem counterintuitive. But upon further analysis, it makes a lot of sense.
Let me explain…
In short, stocks aren’t supposed to trade based on what’s happening right now. Their share prices should reflect what investors believe will happen at some point down the road.
After all, that’s why folks buy stocks in the first place. They want them to go up.
In ivory-tower lingo, stock prices are the present value of expected future cash flows.
But that’s where many investors go wrong. And it happens for two reasons…
First, no plug-and-play model exists for this task.
The future is just too hard to predict. And we don’t even know how far out in the future we should go…
Hardcore financial geeks forecast through infinity. But to do that, they use contortions that only a math professor could love.
Second, investors simply often feel too insecure.
As humans, we face huge emotional pressure to stick with what we see right in front of us. So we inherently assume that the most up-to-date information will persist into the future.
And if it doesn’t, our emotions take over. If a company reports a bad quarter, investors often hammer its stock as if it will never grow again.
But let’s be fair…
Investors don’t act irrationally on purpose. They only act that way because they don’t have enough information to act rationally.
Fortunately, data points for housing stocks are among the easiest to parse. The determining factors of homebuilders’ profits are easy to see and very widely discussed.
Just think about how much commentary you’ve seen on mortgage rates and housing starts.
Few homebuilders buck these trends. And once a homebuilder breaks ground, it’s easy to figure out how long it will take to sell the finished house.
Analysts find it easy to progress from mortgage rates to housing starts to new orders to working down the backlog to final sales. And good data exists for relevant costs as well.
Because mortgage rates and inflation are up, the path to lower 2023 earnings is locked in.
However, here’s where today’s essay gets interesting…
We’re also seeing more chatter about rates nearing their highs. And every piece of rhetoric along those lines builds and reinforces the case for higher earnings in 2024 and beyond.
Even though 2023 earnings will fall, the median homebuilder price-to-earnings ratio (measured on next year’s estimated earnings per share) is 7.8. For S&P 500 companies, it’s 20.4. And median price-to-sales ratios are 1.1 for homebuilders versus 4.4 for the S&P 500.
That tells us homebuilder stocks are undervalued today. So it’s much easier for investors to follow the right path when they’re trying to figure out what will happen down the road.
After all, the future isn’t just about 2023. It also includes 2024, 2025, and beyond.
Good investing,
Marc Gerstein
