12 housing stocks to ride the red-hot market

The U.S. has a housing shortage and a love affair with home improvement, both of which could create tailwinds for this group of housing stocks.

  • By Will Ashworth,
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Economist Robert Shiller believes that the housing market has entered bubble territory. And yet, housing stocks aren't necessarily imperiled.

In a recent interview on CNBC, Shiller emphasized that home prices appear to be driving an increase in housing starts.

"In real terms, the home prices have never been so high," says Shiller, who is a co-founder of the S&P CoreLogic Case-Shiller home price index. "My data goes back over 100 years, so this is something. I don't think that the whole thing is explained by central bank policy. There is something about the sociology of markets that's happening."

Shiller also predicts that housing prices could be a lot lower in 3-5 years, repeating what happened in 2003, which ultimately led to the 2008 financial crisis – and caused homebuilder stocks to crash.

However, while the economist is signaling home prices are too high, the CEOs of some of America's largest homebuilders and investors seeking out surging housing stocks don't seem nearly as concerned about the situation – despite the fact higher lumber costs are adding $36,000 to the price of an average single-family home.

The reason homebuilders aren't so concerned is that America continues to have a significant housing shortfall. The shortfall of homes for prospective home buyers has increased by approximately 50%, from 2.65 million in 2018 to 4.0 million in 2021.

Here are 12 housing stocks to ride this red-hot market. Our selections are based on the shortfall of homes as well as America's ongoing love affair with home improvement. So while half are homebuilder stocks, the other half supply products to the construction industry.

Data is as of June 4. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price.

Home Depot

  • Market value: $330.7 billion
  • Dividend yield: 2.1%
  • Year-to-date (YTD) return: 17.1%

If there's a retailer that has thrived during COVID-19, it's Home Depot (HD). It doesn't hurt that the U.S. is experiencing a tremendous housing and home improvement boom. The company feels the good times are likely to continue throughout 2021 and beyond.

Home Depot reported stellar first-quarter results in May that included same-store sales growth of 29.9% at its U.S. stores, 490 basis points above its strong results a year earlier. On the bottom line, it had net earnings of $4.1 billion, 86% higher than in Q1 2020.

The federal government's stimulus checks combined with people being at home more also helped boost HD's fortunes in the first quarter. Home Depot Chief Financial Officer (CFO) Richard McPhail believes the 10% increase in home values last year certainly didn't hurt this housing stock's cause, either.

"We know that as people's homes increase in value they are more willing to spend and invest in those homes," McPhail told Fortune. "Over a multiyear period we expect to see the housing environment supportive of home improvement demand."

While supply constraints are slowing the rate at which new homes are being built, these issues are expected to be sorted out later in the year, at which time home sales should accelerate.

The supply constraints have helped Home Depot's top and bottom lines, too.

During the company's Q1 2021 conference call, CEO Craig Menear stated that sheets of seven-sixteenths OSB (oriented strand board) were selling for $39.76, more than four times what they were priced at one year ago. As a result of the inflation, the retailer's average ticket increased by 375 basis points in the first quarter.

The home improvement business shows few signs of slowing. That's excellent news for holders of HD and other housing stocks.

Sherwin-Williams

  • Market value: $75.3 billion
  • Dividend yield: 0.8%
  • YTD return: 15.6%

A telltale sign of a well-run company with a talented management team is when one of the executives is recruited away from the firm. That happened to Sherwin-Williams (SHW) in March when Chief Operating Officer (COO) David Sewell resigned to become the head of a company outside the coatings industry.

Sewell had been with Sherwin-Williams for 14 years – not quite as long as CEO John Morikis, who joined the company as a trainee more than 36 years ago.

Analysts like this housing stock. On May 17, Morgan Stanley analyst Vincent Andrews raised his 12-month price target by 15% to $315. Andrews believes the paint and coatings company will continue to perform at an exceptionally high level in 2021 and 2022.

"Increasing conviction in our above-consensus 2021/2022 Sherwin SSS/EPS forecasts following the results of our Fall 2021 contractor survey as well as other recent data points. Recent management commentary about customer backlog and market share gains [are] also supportive," Andrews wrote in a note to clients.

Of the 27 analysts covering SHW, 15 have a Buy or Strong Buy rating on the stock. Only two analysts rate it Sell or Strong Sell, with 10 viewing it as a Hold. The median target price is $300, representing expected upside of 5.9% in the next 12 months or so.

In late April, while reporting its first-quarter earnings, the company said it expects to earn $8.80 a share in fiscal 2021. That values it at slightly more than 32 times its guidance. While relatively expensive, Sherwin-Williams is the leading paint supplier in the U.S., and investors appear happy to pay up for quality.

Lennar

  • Market value: $29.5 billion
  • Dividend yield: 1.0%
  • YTD return: 26.7%

Lennar (LEN), America's largest homebuilder by revenue, has come a long way since it traded at a 52-week low of $25.42 during the March 2020 market correction. A hot housing market is a big reason for its 280% gain in the nearly 15 months since.

Whatever issues Lennar faces regarding supply shortages, its dynamic pricing model – which allows it to set prices based on market conditions – should enable it to continue from the strong demand for new housing.

At the end of its first quarter, the homebuilder had a backlog of 22,077 homes, 25% higher than in the first quarter of 2020. The backlog is expected to generate as much as $9.5 billion in future revenue.

In addition to being busy building new homes, Lennar entered into a joint venture with Centerbridge Partners in March to see the companies develop a $4 billion single-family rental platform. The platform gives median-income Americans the opportunity to own or rent its quality-constructed single-family homes.

"This exciting new venture has an opportunity to scale at a pace we do not believe possible for competitors in the single family rental space, given its direct access to Lennar's pipeline of over 300,000 owned and controlled homesites," says Lennar Co-CEO Rick Beckwitt.

Lennar is innovative to the core, backing Doma Holdings, a company that's developed a technology platform utilizing artificial intelligence (AI) to make real estate closings more affordable. In early March, Doma announced that it would merge with special purpose acquisition company (SPAC) Capitol Investment Corp. V (CAP) to become a public company.

Not only has Lennar invested in Doma – which holds less than 1% of the U.S. title market, but is expected to grow that to 5% by 2023 – it has also committed to the $300 million private investment in public equity (PIPE) that will happen at the same time the merger closes. Several well-known institutional investors have bought into the PIPE, too, including SB Management, a subsidiary of SoftBank Group.

Lennar is the cream of the crop when it comes to housing stocks.

NVR

  • Market value: $17.5 billion
  • Dividend yield: N/A
  • YTD return: 17.9%

NVR (NVR) operates in 33 metropolitan areas in 14 states and the District of Columbia.

Based in Reston, Virginia, the company's first-quarter sales and earnings increased year-over-year by 29% and 42%, respectively, to $2.0 billion and $248.8 million. Net income for both its homebuilding (+69% from the year prior) and mortgage business (+411%) helped drive the strong results in the first quarter.

NVR's backlog of homes during the three-month period increased 42% year-over-year to 12,791. The backlog represents $5.2 billion in revenue. Its new orders in the first quarter were 6,314, 26% higher than a year earlier, while its average price per home was $410,500, a 10.3% improvement.

If you value strong insider ownership when buying a stock, NVR has a significant amount of investment from its directors and executive officers. The 17 people listed in its 2020 proxy statement own 9.0% of the company. CEO Paul Saville, who's been in the top spot since 2005, owns the most at 5.1%.

Not only does NVR have good insider investment, but it also has an executive compensation system that emphasizes return on capital in its calculation of long-term stock awards. Approximately 50% of its stock option grants are based on its return on capital performance relative to its peers.

Not surprisingly, NVR's return on capital grew from 21% in 2015 to 35% in 2020 while its economic earnings – defined as net operating profit after tax (NOPAT) minus weighted average cost of capital (WACC) multiplied by invested capital – grew by 183% to $799 million over the same period.

Interestingly, the company uses stock options rather than restricted share units to compensate its executives for long-term performance. Unlike with restricted share units, the executive would receive no compensation if the housing stock's price decreases between the grant date and vesting date.

That's what I call aligned interests.

Masco

  • Market value: $15.2 billion
  • Dividend yield: 1.6%
  • YTD return: 8.8%

The maker of such well-known brands as Delta faucets and Behr paints had a strong start in 2021.

Masco (MAS) reported first-quarter results at the end of April that beat analyst expectations on both the top- and bottom-line. The company delivered revenues of $1.97 billion over the three-month period, $140 million higher than the consensus estimate. On the bottom line, it earned 89 cents per share during the first quarter, 23 cents higher than analysts anticipated.

The company's conference call highlighted some of the concerns the entire home improvement industry faces due to the ongoing pandemic.

The first issue is raw material prices. The company uses copper and zinc extensively in its various businesses. Prices are currently through the roof. In addition to the commodity costs, freight costs are also higher. It expects these costs to be up in the mid-single-digit range for the remainder of 2021 in both its plumbing (Delta) and decorative (Behr) segments.

The other major issue is the supply chain. In the first quarter, MAS had a difficult time getting certain products promptly. However, it has managed to leverage its size and scale to lean on suppliers to ensure it can meet the demand of its customers.

Masco is not too worried about these issues. As part of its Q1 2021 earnings release, Masco increased its full-year per-share earnings guidance from $3.35 at the midpoint to $3.60, a 7.5% boost. Based on its guidance for 2021, Masco expects sales to grow by at least 10% and earnings per share to be up 15% at the midpoint.

Additionally, MAS generates significant free cash flow – good news for those holding the housing stock.

And it uses some of it to buy back stock. In the first quarter, the company repurchased $303 million of its shares. It expects to allocate an additional $500 million to share repurchases or acquisitions over the remainder of the year. In 2020, it repurchased $727 million of its stock.

PulteGroup

  • Market value: $15.0 billion
  • Dividend yield: 1.0%
  • YTD return: 32.1%

PulteGroup (PHM) is the third-largest homebuilder in the U.S., with operations in 23 states and 42 major markets. Since its founding 70 years ago, it has delivered nearly 750,000 homes. Today, it does so under several different brands, including Centex, Pulte and Del Webb.

Investors ought to be attracted to this housing stock because of its diverse revenue generation. Approximately 29% of its home sales are from first-time home buyers, another 45% moving up from their first purchase and the remaining 26% who aren't ready to slow down but want something a little smaller and less cumbersome to maintain.

The opportunity for homebuilders at the moment is tremendous. Freddie Mac estimates that there is a nationwide demand for 4 million homes. That works out to approximately 1.5 million annually. The number of single-family housing starts in the U.S. over the past 25 years reached that level on two occasions in 2004 and 2005.

The company's focus on profitability and cash flow enable it to allocate its free cash toward dividends, share repurchases and debt repayment. Since 2018, PulteGroup reduced its debt-to-capital ratio from almost 40% to 23.3% in the first quarter. Additionally, the company has increased its share repurchase authorization by $1 billion.

In Q1 2021, PulteGroup's revenues were 17% higher year-over-year at $2.6 billion, with a 12% increase in house closings and a 4% rise in the average selling price to $430,000 during the quarter. In terms of orders and backlog, they increased 31% and 50%, respectively, during the quarter.

PHM's adjusted earnings per share increased by 60% from the year prior to $1.28. That's due in part to a 180-basis-point increase in its gross margin and a 100-basis-point reduction in its adjusted selling, general and administrative (SG&A) expenses during the quarter.

Investors can expect PulteGroup to continue to benefit from the housing boom that has gripped the country. However, with the homebuilding stock trading at 1.3x sales, it's more expensive than its five-year historical average.

Mohawk Industries

  • Market value: $14.0 billion
  • Dividend yield: N/A
  • YTD return: 42.9%

You can tell that Mohawk Industries (MHK) has seen a marked improvement in its business over the past year simply by looking at the housing stock's performance. Year-to-date, it's up nearly 43%, while it has roughly doubled over the past year.

As a point of reference, over the past three-year and five-year periods, its annualized annual returns are a dismal -1.1% and 0.1%, respectively.

Raymond James analyst Sam Darkatsh has a Strong Buy rating on the stock and a $240 target price. The median target price of the 14 analysts covering the stock is $226.83, and as for ratings, seven have it as a Strong Buy, five as a Hold, one as a Sell and one as a Strong Sell. The consensus 2021 earnings estimate is $13.50, which means the homebuilder stock is currently trading at 14.9x earnings.

Mohawk's flooring business is booming at the moment. In the first quarter, it reported record sales of $2.7 billion, 9% higher than its year-ago results, excluding currency. Its adjusted earnings per share of $3.49 were the company's best first-quarter earnings results in its history.

Also in the first three months of the year, MHK's flooring business saw North American sales increase 14.3% from the year prior, while revenues from its flooring business outside of North America rose 31%. Mohawk's flooring business accounts for 65% of sales and 73% of operating profits.

Despite the supply issues stemming from COVID-19, the company's investments in its U.S. trucking fleet and local delivery systems have enabled it to maintain consistent deliveries to its customers.

Mohawk continues to chip away at its cost structure. The company has found $75 million of the $110 million in annual savings it wants to remove from its business. It expects to find the remaining savings by the end of 2021. Its net debt is $1.3 billion, less than 1x its adjusted EBITDA (earnings before interest, taxes, depreciation and amortization).

As a result, MHK expects to make further acquisitions and investments in its business to continue growing sales.

Trex

  • Market value: $11.2 billion
  • Dividend yield: N/A
  • YTD return: 15.5%

You'd be hard-pressed to find a housing stock that's delivered a better annualized total return (price plus dividends) over the past 15 years than Trex (TREX).

Trex is a maker of composite decking and fencing that's made to last longer than traditional wood. And its annualized total return is 24%, more than double the S&P 500 Index (.SPX).

Since Trex went public in April 1999 at $10 a share, it has had three stock splits. The first in May 2014, the second came in June 2018 and the third in September 2020 – with each a two-for-one split.

A $10,000 investment in the company's initial public offering (IPO) would be worth $773,680 today (8,000 shares * $96.71), a compound annual growth rate (CAGR) of 23%. Since going public, Trex's revenues have burst from $49.2 million in 1998 to $880.8 million in 2020, a CAGR of 14%.

In more recent times, Trex has experienced strong sales as consumers opt for decking materials that aren't rising in price nearly as fast as lumber. Trex reported Q1 2021 results in May. The company's net sales rose 23% year-over-year to $246 million, while its earnings per share increased 17% to 42 cents.

"Sustained demand for Trex Residential products and accelerated market share gains from wood drove first-quarter sales growth, laying the foundation for another year of strong double-digit revenue growth in 2021," CEO Bryan Fairbanks says.

Trex has been working hard to increase its capacity at its manufacturing facility in Virginia. The plant expansion will give the company 70% more capacity than it had in 2019, making its composite decking an excellent alternative to wood.

Toll Brothers

  • Market value: $7.8 billion
  • Dividend yield: 1.1%
  • YTD return: 45.6%

The fourth of six traditional homebuilder stocks on this list, Toll Brothers (TOL), got some new coverage from Janney analyst Tyler Batory at the end of April.

Batory initiated coverage of Toll Brothers with a Buy rating and an $80 target price. The analyst believes that TOL's margin expansion combined with changes made to the way it buys land – it's putting less money upfront, which allows it to control more land with fewer dollars – should provide a higher valuation multiple for the housing stock in the future.

"We are especially bullish on its affordable luxury product (41% of communities), which we think fills an underestimated niche and has a large runway for future growth," Batory says.

Toll Brothers' business is performing at a very high level in terms of all the usual metrics.

The company's first quarter of 2021 had revenues of $1.6 billion, 17.4% higher than a year earlier. Home sales revenues were 9% higher to $1.4 billion during the quarter, while land sales jumped 350% to $152.7 million. TOL's pre-tax income was $127.4 million during the three-month period, 93% higher than in Q1 2020.

As for the home sales themselves, Toll Brothers had net signed contracts for 2,874 units during the first quarter, up 59% from a year earlier. It finished the first quarter with a backlog of 8,888 units (+38% year-over-year) worth $7.5 billion. The average selling price of homes in the backlog was $840,900, a modest 0.3% decline from Q1 2020.

Toll Brothers CEO Douglas Yearly Jr. has been very clear about what opportunities lie ahead for the homebuilder.

"Our (Q1 2021) results reflect a robust housing market that continues to benefit from favorable demographic trends, a very tight supply of for-sale homes, stemming from a decade of underproduction, low mortgage rates and a renewed appreciation for the importance of home," Yearly says.

Interestingly, buyers appear to be willing to spend more on their homes. In Q1 2021, TOL homebuyers added $170,000, or roughly 26%, to the base price for upgrades, lot premiums and other options.

That's a good thing if you own this housing stock.

Alarm.com

  • Market value: $4.0 billion
  • Dividend yield: N/A
  • YTD return: -22.8%

Alarm.com (ALRM) is the only housing stock of the 12 in this article that is in negative territory for the year to date. It has been left in because, despite the correction in 2021, the company's cloud-based security and home automation platform has managed to deliver for shareholders over the long haul.

In the past 52 weeks, its total return is 42.6%. Over the past five years, its annualized total return is 30.0%, considerably higher than both its peers and the broader U.S. stock market.

In the first quarter ended March 31, Alarm.com saw revenues grow 13.5% to $172.5 million, while non-GAAP (generally accepted accounting principles) adjusted net income rose 23.4% to $25.8 million.

While ALRM experienced favorable conditions in the U.S. and Canadian residential markets, continuing from the fourth quarter of 2020, its commercial business remains below pre-pandemic sales levels.

The company has launched some innovative products as a result of COVID-19. It introduced a touchless video doorbell in the first quarter for residential customers, and has received positive feedback from consumers.

In the commercial area, Alarm.com launched its Smarter Business temperature monitoring for companies such as restaurants and grocery stores following stringent health and safety requirements. The system includes comprehensive monitoring and customized alerts, such letting subscribers know if a refrigerator door was left open.

ALRM's commercial plus service plan has gained significant traction with businesses, seeing 35% growth since 2018. The Smarter Business temperature monitoring is expected to help grow this subscription plan, which is billed annually and charges the equivalent of $23.95 per month.

From a balance sheet perspective, Alarm.com operates from a net cash position. At the end of the first quarter, it had $180 million in net cash on its balance sheet, double what it was at the end of 2020.

Taylor Morrison Home

  • Market value: $3.8 billion
  • Dividend yield: N/A
  • YTD return: 15.8%

Before getting into some of the homebuilder's recent financial stats, it's important to note that Taylor Morrison Home (TMHC) is a leader in the construction industry regarding gender diversity. The company has a male-to-female employee ratio of 53% to 47%, a fact that has helped it be included in Bloomberg's Gender-Equality Index for three straight years.

"While many misconceptions remain in the field for women, we celebrate the progress within the industry and Taylor Morrison's consistent growth in female representation. Men and women bring intrinsic differences to construction, making us a stronger organization and homebuilder," says Charissa Wagner, Senior Vice President of People Development and Operations at TMHC.

The significant presence of women, both on the job site and in its offices, will continue to be a big part of the company culture. That's excellent news if you're a shareholder of this housing stock.

In late April, CEO Sheryl Palmer discussed the company's Q1 2021 results in a conference call with analysts. Palmer highlighted the fact that TMHC finished the quarter with a backlog of more than 10,000 homes, a record for the company, and a total of more than 73,000 homebuilding lots, providing Taylor Morrison with a long pathway for growth.

To improve the customer service experience, the company has created a virtual home configuration and reservation system that allows potential customers to pick a homesite and design a floor plan entirely online. A first-of-its-kind, this tool is part of the TMHC's push to increase its return on equity from the mid-teens in 2021 to well beyond that in the years to come.

The company continues to grow Esplanade, its active adult home brand that started in Florida but is now being rolled out across the country. It recently opened two communities in California and has another planned for North Carolina later this year.

The active adult segment is desirable because many of these buyers pay with cash, are less affected by interest rates and generate higher profits for the company.

Tri Pointe Homes

  • Market value: $2.8 billion
  • Dividend yield: N/A
  • YTD return: 35.8%

Tri Pointe Homes (TPH) is based in California, where it generates 43% of its home sales revenue. It also operates in nine other states and the District of Columbia. Arizona is the second-largest revenue generator at 15%, followed by Washington state at 11%.

In the first quarter, TPH's net new home orders increased 20% to 1,987, deliveries jumped 18% to 1,126, with an average selling price of $636,000 – 2% higher than in Q1 2020. Tri Pointe Homes also saw its backlog grow 56% to 3,825 homes, a dollar value of $2.5 billion in future revenue.

More importantly, the company's adjusted homebuilding gross margin during the quarter increased by 340 basis points to 26.8%. Combined with a 250-basis-point reduction in its SG&A expense to 11.4% over the three-month period, TPH saw a 126% increase in pre-tax income. On a per-share basis, earnings grew 146% from 24 cents a share in Q1 2020 to 59 cents in Q1 2021.

Tri Pointe finished the first quarter with a total of 36,843 lots either owned or controlled, with an inventory value of $3.0 billion. Based on 5,291 deliveries over the past 12 months through March 31, the company has an implied supply of seven years.

In 2021, Tri Pointe expects to open 70 new communities, and finish the year with roughly 120 and 130 active selling ones. It anticipates deliveries of at least 6,000 homes this year at an average selling price of at least $620,000 and a gross margin of 22.5% at the midpoint.

Of the nine analysts covering the housing stock, five have a Buy rating and four say it's a Hold. The median target price is $27, representing expected upside of 15.2% over the next 12 months or so. In terms of valuation, TPH is trading at 7.1x its 2021 earnings estimate of $3.29 per share.

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