Friday, November 17, 2006

Meritage Homes (MTH)

I think the best publically traded home builder is probably Meritage Homes

Here is a plot of the book value of MTH over the past 10 years. Look at how stable this growth is, about 37%.

They have one of the highest Return On Equity (ROE) of the builders, about 30%. They retain all earnings and grow at about their ROE which is good. Debt level and leverage is reasonable. P/B is about 1.2. Earnings yield (EBIT/EV) is about 24% although earning of all hombuilders is plummetting. The only home builder with better numbers is NVR which has management ethics problems.

The only problem with Meritage and the reason that the market gives them a lower valuation then say Centex or Toll Brothers is that they are not very geographically diversified. They build houses in just 6 states. Texas, Arizona, California, Colorado and Florida and Nevada. These states may be some of the more bubbly ones and so people think this is a riskier stock. However these are also the best states to be in. These markets will have the most growth over the coming decade and that is why they are there and this is partly why there are more profitable than the others. Buying a home builder now only has one real risk. That is liquidity risk. They can go bankrupt. This happened to big home builders before. US Homes, NVR and UDC all went bankrupt. NVR just started out and walked right into than crash of 1991-1992. After coming out a bankruptcy they became one of the best stock to own over the 10 year period of 1995-2005; their stock price grew by a factor of 53. Home builders in general look like great long term investments right now. They just need to avoid going bankrupt due to a liquidity crisis during this crash. For that they need, low debt to equity, a decent available line of credit which nearly all big builders have (maybe TOA the exception).

Other home builders that I am looking at are TOL, RYL and HOV. I think the trick is not to pick the biggest and most diversified but rather look for the most profitable and best managed which will do the best over the long term. It probably would pay a bit to diversify a some between a few home builders since you never know.