After a 60% Surge in 2023, Are Homebuilders Still Undervalued Compared to the Broader Market?
Despite surging mortgage rates, the homebuilding sector delivered an outstanding performance in 2023, soaring by 60% for the year - its best annual performance since 2012. This outpaced major stock indices, including the $S&P 500 Index(.SPX.US$'s 24.2%, $Nasdaq Composite Index(.IXIC.US$'s 43.4%, and $Dow Jones Industrial Average(.DJI.US$'s 13.70%.
However, data shows that despite this remarkable surge, homebuilders are currently trading at a more substantial discount to the S&P 500 than the 10-year average in terms of valuation multiples such as P/B, P/S, and P/E ratios, indicating that the sector seems to be relatively affordable when compared to the wider market.
Currently, the homebuilding sector still trades at a 42% discount to the S&P 500 in terms of forward P/E, significantly higher than the 10-year average of 20%. In addition, the sector's relative discounts to the S&P 500 in terms of P/B and P/S are 20% and 50%, respectively, which is also higher than the historical averages of 12% and 45%. This means that even after experiencing a significant surge in 2023, based on traditional relative valuation methods, homebuilding stocks still appear undervalued relative to the broader market, if historical experience is any guide.
Looking at individual stocks, some major homebuilders currently have a certain advantage in terms of valuation compared to the broader market. Bloomberg data shows that the current PE ratio of the S&P 500 is 22.99, and the PB ratio is 4.49, while the valuations of many homebuilding stocks are still below these levels.
1. The Fed's monetary policy shift and the upcoming rate cuts are the biggest tailwinds
The December FOMC minutes reveal that Fed officials have acknowledged that "the policy rate has likely peaked" and have suggested that "a lower target range for the federal funds rate would be appropriate by the end of 2024." Although the minutes do not mention a specific timeline for rate cuts, according to the CME FedWatch tool, futures traders now expect the first rate cut to be possible as early as March, and by the end of the year, there is a 76.2% probability of at least a 150bp rate cut for the year.
Data shows that the US 30-year and 15-year fixed-rate mortgage rates have peaked and begun to decline since the end of October 2023. As of January 11th, the US-30-Year Fixed-Rate Mortgage Rate and 15-Year Fixed-Rate Mortgage Rate were 6.66% and 5.87%, respectively, both down more than 110bp from their peaks last year.With the gradual implementation of Fed rate cuts this year, further declines in mortgage rates are expected to boost housing demand and the sales of homebuilders.
Therefore, builders' outlook is also showing an increasing trend of optimism. According to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI), homebuilder sentiment improved in December, representing the first positive change in five months.
2. Tight housing inventory will continue to boost homebuilders
Due to homeowners' reluctance to give up their homes financed at low rates, the resale market inventory is at a low level in 2023, creating an opportunity for new home construction and becoming a significant catalyst for boosting homebuilders' sales performance. Data shows that US new home construction unexpectedly rose to a six-month high in November, with a monthly rate of 1.56 million units, up 14.8% from the previous month. Meanwhile, single-family home construction jumped 18%, reaching the highest level since April 2022. In addition, the new-home sales as a share of the entire housing market are currently around 30%, likely approaching the peak level.
Moving into 2024, the structural shortage of housing and sticky housing prices may continue to support homebuilders' stocks. Seaport Research analyst Kenneth Zener further stated that even with lower rates increasing inventory and shifting sales from new homes to existing ones, existing homeowners who decide to sell their homes will also be looking for new places to live, further stimulating demand. This means that homebuilders will continue to be in a favorable position.
“The new home market has been extraordinary in 2023, and I think heading into 2024, we’re going to have the golden age of new home construction,” David O’Reilly, CEO of Howard Hughes said.
3. The potential increase in profit margins is another positive development
Considering that many homebuilders launched various incentive measures in 2023 to offset the demand suppression caused by high interest rates, including reducing mortgage rates and lowering prices, Bank of America analysts believe that in 2024, with homebuilders reducing incentive measures, lower rates will increase sales and profit margins.
BTIG analyst Carl Reichardt has warned that the homebuilding industry may have hit a ceiling. Reichardt stated that the majority of the stocks he covers are fairly valued, and he added that investors will need to see better-than-expected earnings growth in the long term.
Source: moomoo, Bloomberg, Barchart, Housingwire, MacroMicro
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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