The U.S. Census Bureau and U.S. Department of Housing and Urban Development released the latest figures for new home sales at the end of October. September sales, while down slightly from August, were still 32% above the same month in 2019. Contract signings were up 20.5% year over year. Despite continuing joblessness that exceeds the depths of the 2008-2009 financial crisis and a pandemic that continues to disrupt daily life, housing has been red hot all summer thanks mostly to record-low interest rates.
With housing sales robust, you might expect the stocks of U.S. homebuilders D.R. Horton (NYSE:DHI), Lennar (NYSE:LEN), and PulteGroup (NYSE:PHM), to be near all-time highs. If you guessed that, you’d be right. What you might not guess is that even near all-time highs, these stocks are absurdly cheap. Investors have to be cautious, though. Homebuilder stocks can be deceiving, trading at extremely low price-to-earnings multiples during the good times, and lofty ones during a downturn.
A better tool to analyze valuation for homebuilders is the enterprise value (EV)-to-EBITDA ratio — the company’s market cap plus debt divided by earnings before interest, taxes, depreciation, and amortization. This ratio allows us to compare the value of a company to its cash earnings without the confusion of non-cash expenses. Let’s take a closer look at these three absurdly cheap homebuilder stocks.
1. D.R. Horton
D.R. Horton is America’s largest homebuilder by market cap and accounts for 17% market share of U.S. housing sales. The company employs a strategy of consistently selling homes rather than building houses with the highest profit margins. This approach has led to the nickname “the Walmart of builders.” In the most recent quarter, the average sales price for the company’s homes was $296,450. This emphasis on entry-level homes — many between $120,000 and $150,000 — has served D.R. Horton well in the current environment, where affordable houses are hard to find.
For the nine months ended June 30, net income increased to $13.5 billion, an 11% increase from $12.2 billion last year. The number of homes closed increased 10% year over year and the sales order backlog increased 41%, indicating the demand will not wane anytime soon. The EV-to-EBITDA ratio for various industries of the S&P 500 ranged from 12 (utilities and communication) to 19 (consumer discretionary). On that comparison, and the company’s recent history, D.R. Horton is cheap.
Lennar develops multi-family properties and no-frills single-family homes, and also holds a 17% market share. In 2019, the company further pivoted to entry-level houses. For comparison with D.R. Horton, the average selling price of the company’s single-family homes was $396,000 in the quarter ended Aug. 31. Orders during the quarter rose 16% and backlog increased 4%, with profit up 30% in the same period in 2019.
Lennar is well-positioned in fast-growing geographies, with 29% of its sales in Florida and 16% in Texas, the fifth and seventh fastest-growing states, respectively. Management has pushed to reduce the amount of land inventory, perhaps fearing a slowdown, reducing years of homesites from 4.4 years to 3.8 years in the latest quarter. Similar to D.R. Horton, Lennar sits near its low for the EV-to-EBITDA ratio in the past 10 years.
Pulte’s home sales are more evenly spread across generational stages, with 29% first-time buyers, 45% move-up homes, and 26% age-minimum — or active adult — communities. This enables the company to capture an 8.5% market share. Its customer-designed homes are pricier, reflected in an average home price of $438,000 in the most recent quarter. During that quarter, ended Sept. 30, net new orders increased 36% and backlog expanded by 29%.
As the oldest members of Generation X begin to turn 55, and houses get converted to offices, gyms, and multi-generational care facilities, Pulte’s built-to-order offerings are best suited for our changing world. And like its homebuilding competitors, the stock trades at an EV-to-EBITDA ratio far below the market and near its decade low.