If the market for new homes continues to expand rapidly, KB Home (NYSE:KBH) will likely be one of the biggest winners. But, if higher mortgage rates cause more slack in home buying demand, KB Home definitely has more to lose.
Analysts expect the company to earn $1.14 per share next year (fiscal year end November, 2014), which is up more than 300% from the current year estimates of $0.26. But, although a 300% growth rate is very attractive, it is unlikely that the company can sustain growth anywhere close to this level past 2014.
KB Home (NYSE:KBH) is growing earnings after a severe slump, and is vulnerable to any decline in demand for new homes. It would not be unreasonable for investors to place a price-earnings multiple of 10 or 12 times forward estimates, given the uncertainty in the market. And that would represent a stock price between $11.40 and $13.70 — quite a drop from the current price.
Reasonably priced, most to lose
While Lennar Corporation (NYSE:LEN) sells some of the most reasonably priced new homes, this also means that the company’s future growth may be much more affected by interest rates.
While luxury homebuilders such as Toll Brothers Inc (NYSE:TOL) market their homes to affluent buyers with plenty of capital, Lennar pitches its homes to potential first-time home buyers based on the cost savings of buying versus renting.
As interest rates rise, this potential savings becomes less distinguishable. Lennar’s customers don’t typically look at the overall price of the house as much as the monthly cost of the mortgage (plus insurance, utilities, HOA fees etc.).
Shares of Lennar are currently trading near 16 times next year’s expected earnings (fiscal year end November, 2014). While this is lower than both KB Home (NYSE:KBH) and Toll Brothers Inc (NYSE:TOL), the discounted valuation is justified given the company’s risk to mortgage rates as well as the overall employment environment.
Too much risk to justify
Home builders have been a tremendous investment as the housing market rebounded from a severe recession. But now that interest rates are on the rise, these stocks could wind up being stagnant investments for a significant amount of time, or they could decline materially as investors account for new risks.
Rather than waiting to see exactly how the Fed will proceed, I recommend selling out of home building stocks and looking for more attractive growth opportunities. The key here is managing risk before a decline in these stocks adversely affects the value of your portfolio.
The article Rising Mortgage Rates Spell Trouble for Homebuilders originally appeared on Fool.com and is written by Zachary Scheidt.
Zachary Scheidt has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Zachary is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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