Is now the time to be looking to buy homebuiders?

I was looking at homebuilders early in 2007 as they seemed cheap. Most were trading at or below book value and had fallen by around 50% in price. Surely I couldn’t go wrong picking up some of my favourites! A few things stopped from buying then and with prices down substantially since I thought now would be a good time to have a fresh look.
This picture is of a house that was full of weapons being blown up with the help of five sticks of C4. Rather apt analogy to the housing market.

What stopped me buying Home Builders in 2007?

• This excellent article, Time to Buy Homebulders, at Toro’s Running of the Bulls sewed the seed of doubt. It a great article and highlighted just how much more downside was possible.
• Then I thought how I am generally early to the party. I often buy too early, believing the knife has stopped falling or at least is close to the floor, when in reality I often have no idea where the floor is.
• Thinking about my early entries and reviewing my history, two things struck me. Despite both having studied psychology at university and considering investor psychology as one of my strengths I had repeatedly fallen in to the cognitive trap of anchoring. I was anchoring to past prices and valuation metrics which were more fluid than I realised. My second realisation was that in my eagerness to buy I was neglecting the time value of money and the lost opportunity cost by commiting funds.
• I knew where the ceiling was and from that was estimating where the floor might be. That is a poor substitute for analytically determing where the floor is likely to be. I decided right then I could improve my timing by using history to provide more accurate indiciations as to where the floor was likely to be.
• Everyone was talking about buying home builders. This is often a give away that it is not the right to buy. You want to buy when almost no-one is talking about the company or sector.

I decided to wait, to practice the art of patience. Of course every sell and every wait decision I’ve made in the last 18 months now with hindsight look like good decisions. To elevate those wait decisions to brilliant I need to buy when true value approaches.

Time for a Fresh Look at Home Builders

Here is the list Toro presented back in March 2007.

Toro concluded “My guess is that the group will bottom higher than the 0.47x book value it hit in 1991/1992 but lower than 0.76x it bottomed at in 1999/2000.  Maybe the group bottoms at 60%-70% of book value.  If it does, I plan to close my eyes and buy.  And when they double, I’ll sell because the group may move sideways for years thereafter.”

So how do the homebuilders stack up now?

The current ratio for builders is inflated by their holding of inventory as short term assets.

If we are anywhere near the bottom in housing then homebuilders are looking attractive. Remember prices will turn up six to nine months ahead of an eventual bottom in housing, so we only have to be close now to get a cigar.

I haven’t devised my approach to homebuilders yet. Should I buy strength for lower risk and reward or a basket of dogs for higher risk and reward? First up I’ll check ETF’s for builders and then I want to do is dive deeper in to the specific builders. I also want to see how much book value each builder and the group in total has written off.

Homebuilder watchlist.

Homebuilders ETFs

• iShares Dow Jones U.S. Home Construction (ITB) often called the best “pure play” ETF for residential home builders. It is down 77% from ’07 highs.
• SPDR S&P Homebuilders ETF (XHB) Down 66% from ’07 highs.
• PowerShares Dynamic Building & Construction Portfolio (PKB) Down 50%.

• More on real estate at Toro’s Running of the Bulls

Related posts:

1. Case-Shiller Housing Update: Home builders Revisited