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Builder of Homes Could Build Your Portfolio

Tuesday, March 31st, 2015

I explained last week that new-home sales — 539,000 on an annual basis — came in far higher than the estimate of 462,000.

Also of importance was that the supply inventory of new homes was only 4.7 months, an inventory level not seen since the summer of 2013.

As an investor, I like to find companies that have strong fundamentals but also good growth potential. I see the economy improving, meaning a demand for more houses and a short supply of new homes.

So I decided to look at a homebuilder to see if there is still some value in homebuilding stocks.

I chose DR Horton Inc. (NYSE: DHI). The stock has a 52-week high of $27.89 and a 52-week low of $19.29. Unfortunately, the current stock price is closer to the 52-week high, trading about $26.50.

The price-earnings ratio over the past 12 months is 17.6, well below the industry average of 43.7.

Price to sales appears to be expensive for the company, checking in at 1.1, more than twice the industry average of 0.51.

I would say a very important ratio for a builder would be the price to tangible book value. DR Horton has a price to tangible value of only 1.90, well below the 11.50 for the industry average, showing investors that they are paying a good price for the tangible assets.

One of the valuation ratios that I look at is the price to cash flow, which is 16.5 for the company, slightly higher than the industry average at 14.7.

I will point out that the company does pay a small dividend of 0.9 percent; however, it uses only 13 percent of its earnings to pay that dividend compared with 19 percent for the industry average.

Sales over the past 12 months compared with the previous 12 months look very good, showing a 30 percent gain, well above the industry gain of 1.6 percent over the same period.

The earnings per share for DR Horton grew by only 3.8 percent over the last 12 months, compared with the previous 12 months, somewhat disappointing after seeing such a large sales gain. However, that 3.8 percent, when compared with the industry average decline of 48 percent over the same period, makes me feel much better.

Homebuilders have a slightly different balance sheet from other companies because they do not look at current assets or current liabilities.

I checked the cash of the company and it stands at $541 million, which is less than a year ago when it was $820 million. But the company appears to be busy building homes, as its total inventory has increased from $6.5 billion one year ago to the current $8 billion. I think that is a positive with such low inventory of new homes.

The debt to equity for DR Horton is higher than the industry average of 45.3, coming in at 70.8. While the debt is higher, it is not excessive. It appears that the company is building more homes for sale with the inventory increasing by $1.5 billion, and it must be using borrowed money to build some of these homes.

But again, I will point out that it is not going overboard. If you invest in this company, watch it closely to make sure the debt does not increase dramatically.

Return on equity for DR Horton checks in at 11.7 percent, far greater than the industry average of 4.1 percent. Normally, I like to see a higher return of equity — about 15 percent — but because of the current low inventory of new homes, I will take a little bit less on my ROE.

The net profit margin is very attractive at 6.4 percent, compared with the industry average of 1.2 percent, which means for every $100,000 worth of product the company sells, it makes $6,400.

The company appears to have some issues in efficiency when it comes to receivable turnover and inventory turnover. Before investing in this company, I want to understand why the receivable turnover for the past 12 months is not material when the industry turned over its receivables 5.7 times.

Also of concern to me was the inventory turnover at 0.94 for the past 12 months when the industry was at 15.8 times.

The forward earnings on general, accepted accounting principles are $1.86 for the fiscal year ending September 2015 and then jumped to $2.13 for the fiscal year ending September 2016, which is only about 17 months away.

If investors want to go out a little bit farther and look at the GAAP earnings for September 2017, the earnings-per-share estimate jumps to $2.50.

Using a multiple of 16.5, that would yield a target sell price of $41.25 for a gain of roughly 55 percent — not a bad return for patient investors who can look forward to the fall of 2017.

Do you have a question or a company you would like us to take a look at?
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