Is Hovnanian Near the Ceiling?
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By Stephen D. Simpson, CFA
09/09/2005

Usually, finding a stock with a low P/E is an indication that
investors don’t expect a whole lot from the company in question. Yet
even though Hovnanian_(NYSE: HOV)_
() missed estimates by
only a small amount and lowered future guidance fairly modestly, the
Street responded by taking down the shares of this homebuilder by
about 7%.

Of course, homebuilders aren’t your run-of-the-mill single-digit P/E
stocks. There’s that purported bubble to contend with. Everyone knows
(or at least assumes to know) that this boom in construction of new
housing has to end eventually, so a lot of investors and analysts sift
through these earnings announcements for the merest hints of an “aha,
I told you so” moment.

On the surface, there’s not a lot to really hate about Hovnanian’s
quarterly report. Sales rose 24%, earnings climbed 32%, and
homebuilding gross margins expanded. Deliveries of new homes increased
by only about 6% in unit terms, but the value of those homes was about
23% higher.

Guidance, though, was the issue. Although company executives stuck to
their guns and pointed out that they beat their own guidance, that’s
like pointing out the price of nutmeg in Batavia — in other words,
pretty irrelevant.

True, it’s not the company’s fault if analysts get out in front of
management’s own projections, but that’s the way the Wall Street world
works. Speaking of that guidance, though, management said that sales
prices on new homes were moderating, and the company lowered guidance
for the next two years by about 4%-5% from prior mean estimates.

Pretty much everywhere you look, you see homebuilders trading at
single-digit P/E multiples. “So,” the novice investor asks, “how could
I possibly lose if I buy stocks like Hovnanian, D.R.Horton_(NYSE:
DHI)_ () , Lennar_(NYSE:
LEN)_ () , or
Centex_(NYSE: CTX)_ ()
?” Well, what happens if the bottom drops out of the earnings part of
the P/E ratio? This is how, and why, cyclical stocks draw in the
unwitting when the stocks approach their cyclical peaks — the stocks
look cheap until you realize the risk that earnings have peaked.

Have Hovnanian and its brethren peaked? Honestly, I don’t know. What I
do know is that the returns on equity we’re seeing in the sector
aren’t sustainable — unless we’re all going to own two or three
houses apiece. That suggests to me, then, that the risk/reward ratio
in these stocks is tilted too much toward “risk” for my comfort.

For more homely Takes:
* _Bad-Mouthing the Bubble_
()
* _Behind the Bubble Babble_
( m)
* _Don’t Get Crushed by Your Home_
( ary05081505.htm)
* _Home Sweet Homebuilder_
()
Fool contributor _Stephen Simpson_ (mailto:tuonela.fool@gmail.com) has no
financial interest in any stocks mentioned (that means he’s neither long nor
short the shares).

The Motley Fool.