Friday, September 19, 2008

For Whom the Bell Tolls: Homebuilders' Coming Demise

Judging by the recent 60% rise in the stock of luxury homebuilder Toll Brothers, Inc., you'd think a new high-end housing boom is just around the corner:

Please go to to view the 2 charts.

Various cheerleading pundits like Cramer are tripping over themselves with excitement that the homebuilders "have bottomed" and "now is the time to buy" because the stock market is a "discounting machine" which is anticipating a resurgence of new luxury home buyers in 4-6 months.

Uh, what planet are the housing-Bull pundits surveying? Did any of them notice these little bits of reality which might puncture their anticipated new-housing bubble?

1. The surfeit (i.e. rising inventory) of existing luxury homes currently owned by desperate sellers and banks who would love to unload then onto any willing (and solvent) buyer.

2. A tightening of lending standards which has removed the vast majority of bubble-era buyers from the pool of potential buyers.

3. A reduction to near-zero of the market for mortgage-backed securities, which removes a huge market for new mortgages.

4. As the economy slides deeper into recession, the few remaining qualified buyers of new luxury homes who don't already own a luxury home or three will find their incomes slashed and/or their jobs lost.

5. With no bottom in sight on house prices in any market or segment, the few remaining qualified buyers are increasingly reluctant to bet hundreds of thousands of dollars that they are "catching the falling knife" at the bottom.

6. Any qualified buyer of a luxury home in any market can buy a foreclosed/distressed/ short-sale luxury house for far less than Toll Brothers or any builder can profitably build and market an equivalent home.

For a more realistic view of where TOL might go when reality intrudes on the fantasy of another housing boom starting four months from now, let's look at a 10-year chart of TOL.

Before we make a few observations, please read the HUGE GIANT BIG FAT DISCLAIMER below. This is not investment advice, it is merely my observations about these charts. Disclosure: I own puts on TOL (i.e. a bet the stock will decline.)

1. In the last recession circa 1990-91, TOL slid below a $1. Since that recession was mere child's play compared to the one we are just beginning, why would anyone expect TOL to do better now than it did in 1991?

2. The recent price of $25 is in line with the price of TOL in 2004, in the midst of the greatest housing boom in a generation. At $25/share, this stock has fully priced in a housing boom just as tremendous as the one which exploded in 2004.

If that is simply not realistic, this stock is incredibly overvalued.

3. Even its recent low around $16 is in line with the value the market placed on the company and its prospects for future profits in 2003, when the housing boom was in full swing.

4. In the "normal business" era around 2000, when the economy was booming and people were buying new homes, but there was no credit/housing bubble, TOL was valued at about $4. This certainly looks like a reasonable target for this stock, with the caveat that if business gets worse than 1999-2000, then even $4/share looks awfully rich. Sub-$1 is the historic range for this stock in "bad times," not $25/share.

What can I say but fantasies (i.e. another housing boom) die hard? Given the facts of stupendous inventory, recession, tightening lending standards, falling housing prices, etc., we can anticipate some national homebuilders sliding into insolvency. It is not out of the realm of possibility that all national homebuilders will be essentially liquidated in the coming years.

(For more on the trends which are acting against another housing boom, please refer to my new "little book of big ideas" Weblogs & New Media: Marketing in Crisis for more on the fundamental trends which are firmly in place globally. (Only $10.99, such a deal! Only 70 pages long, it's perfect for a few hour break from your usual toil.) New essay on leadership by Chris Sullins: First, Do No Harm

Reader Comments

George S.
I have been reading your posts for over one year; this is my first email to you.
You have really good stuff. I have purchased two copies of your new book on "Weblogs..."
Charles Babson, if you know the name, said that he knew a stock market crash was coming in the late 1920's because the moral character of the majority of the people was corrupt--his prediction was based on morality, not charts, stock prices, earnings, etc. If 51% or more of the people were honest, then the economy would survive; if 51% or more of the people were liars, then we would be toast. How right he was.
Just a thought for you.

Harun I.

All the talk of Paulson working on a plan for the taxpayer to absorb all the bad paper made shareholders happy? At least that is what the pundits looking for a “reason” are trumpeting. I think he and his master are criminally insane.

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