Screening for Low Price-to-Book Homebuilders
I’m sharing a recent write up of my attempt to come up with a winning screen for homebuilder stocks. It is essentially a reprint from my blog: https://wordpress.com/posts/dailyscreenz.home.blog
Introduction
In the stock market, homebuilders sit squarely in the cyclical equity camp and usually in the value, and sometimes deep value part of the pond. In this quirky industry you have companies benefiting from long-term secular trends (e.g., think of condos, cookie cutter homes, planned “lifestyle” communities in sun-soaked climates) that trade at low price-to-earnings ratios, some below 10 times earnings.
The industry is prone to boom-bust cycles and sensitivity to interest/mortgage rates, and these dynamics make it a tricky, volatile place for anyone trying to build a winning stock screen over short-to-intermediate holding periods. Okay, enough intro prep talk, let us get into the screening pro-cess (as our Canadian friends say)!
Homebuilders
In the Russell 3000 Index there are give or take 21 or so homebuilder stocks. You probably will recognize some of the names, and I bet there is a decent chance that you live in a home or community that was built by one of these companies. Here are the top 10 names of the companies ranked by market cap (as of June 30, 2021):
The data shows us the uncommon combination of low P/E ratios and strong growth. I can only explain the low P/E ratios as perhaps being driven by the investing public’s fear of cyclicality and/or interest rates. I’ll leave the industry dynamics to those of you with more time on your hands to delve further.
Anyway, homebuilders, as you’ll see, have put up strong investment returns along side the strong growth. What this means is that the industry has been tough to beat for anyone creating an active investment strategy. To judge how well our screen performs we will use the iShares U.S. Home Construction ETF (Ticker: ITB), which includes companies, as the name implies, in the home construction industry (if you are curious, D.H. Horton and Lennar make up approximately 28% of the ETF).
A Homebuilder Industry Screen
Because the homebuilding industry is cyclical, building screens based on growth doesn’t work well since you will inevitably load up just before the bust in the cycle. I tried several of these types of screens without luck. I also tried an annual screen but this also didn’t work because of the volatility. What I settled on was a tried-and- true low price-to-book screen that reset on a quarterly basis. To avoid getting caught in a high leverage credit play I also made sure the companies had less than 50% liabilities to assets (e.g., my shorthand for loan-to-value) in addition to have a credible market cap (over $500 million).
Low Price-to-Book Homebuilders Screen
Stock Universe: Russell 3000 Index Homebuilders
Rebalancing Frequency: Quarterly
Screen Criteria
Total Liabilities to Total Assets <.5
Market Cap > $500 million
Price-to-Book <1
Summary of Results
It is now trendy for investment wonks to trash price-to-book as a useless indicator and yet, time and again, I see in the data that price-to-book delivers excellent results as part of value-oriented stocks screens. You can see for yourself how the screen performed in the attached return table covering the five-years through 2020.
It is a narrow screen, meaning that in some periods it doesn’t screen in a lot of companies. The best part of the screen was that it caught the COVID bottom, which led to outsized results in 2020. Even counting the zero return in 2017, when the screen was essentially inactive, it topped the ETF over the five-years ending 2020 by over 4% per year. Not bad at all!
