Homebuilder Stock Articles Raise Questions – And Exclamations

Wednesday, February 24, 2010

On Monday, Bloomberg reported, “Homebuilding Stocks Seen Rising Too Far, Too Fast.”  The reporter included a graph that shows homebuilders far outperforming the stock market year-to-date. Other publications, including The Wall Street Journal, picked up the theme, helping the stocks to sell off more sharply than the market on Tuesday. The problem is that the information supporting the conclusion and that graph is wrong. Here’s what happened and why we need always to be alert and not accept articles at face value.

Here is how the Bloomberg article begins:

Homebuilders’ soaring share prices this year are anything but “a signal of things to come,” according to Brian Belski, chief investment strategist at Oppenheimer & Co.

“Earnings growth and operating performance remain deeply depressed” three years after they collapsed, and the industry is unlikely to return to profitability any time soon, Belski wrote today in a report.

As the CHART OF THE DAY shows, the Standard & Poor’s 500 Homebuilding Index — composed of D.R. Horton Inc. (DHI), Lennar Corp. (LEN) and Pulte Homes Inc. (PHM) — ended last week with a 21 percent gain for the year. The advance compares with a 0.5 percent loss for the S&P 500.

So, what’s wrong?

The first problem is that only three homebuilders are used to represent the industry, which has over fifteen public companies. Ranked by market capitalization, the 1st and 4th largest homebuilders were left out: NVR Inc. (NVR) and Toll Brothers Inc. (TOL). How important was this omission? Very. The table shows the effect:

Notice how adding the two companies cuts the performance by almost one-half. Even five companies is a small sample. One stock (in this case, Lennar) can throw off the average results. Lennar was up over 25% in the first few days of January, and that helps push the average up significantly. Overall, we see performance dropping from the article’s 21% to under 9%.

Another problem is using a less-than two-month performance calculation to make a judgment. As I wrote in early January (“A Robust Housing Market – 2010’s Biggest Surprise?”), housing was looking up and homebuilders could benefit. Therefore, this relatively quick rise isn’t an indicator of speculation run amok – rather it’s the result of a recuperating industry’s outlook brightening.

Finally, I want to address an all-too-frequent occurrence: namely, flimsy articles that overly excite or upset investors. Take this homebuilder article. It is terribly flawed – it would receive a “D” in a basic investment college class. How on earth did Oppenheimer’s Chief Investment Strategist conduct such a poor analysis? And, why did Bloomberg and The Wall Street Journal so willingly take one person’s comments without support and push it out with dramatic headlines?

We don’t really need to answer these questions. We just need to read with a sharp eye. I have long had a placard on my desk that reads, “Question everything.” With investing and Wall Street, that advice never becomes unnecessary.

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