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rijk
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buffett has repeatedly stated that it is only a matter of time for construction to rebound with family formations > 1 million and new starts < 500k

 

since the sector is clearly out of favor, there might be some interesting opportunities here...

 

most home builders that are still around have adjusted their business models to current economic reality and operate at break even levels at a fraction of the peak years activity....

 

an "orientational dive" in the sector yields the following quantitative information, feedback and qualitative comments would be highly appreciated.....

 

the companies are ranked from strong to weak (financial staying power), i used average 2001-2004 earning to estimate earnings power, knowing that this method is far from accurate but represents, i hope, a conservative valuation approach

 

MDC

- very strong equity buffer/staying power, $1 B equity, $1 B debt, $1 B cash

- earnings power $200 M and MC $1.2 B = P/E 6

- Whitman sold in 2010 with significant loss????

- $200 M fully provided DTA

- P/BV= 1.2

 

DHI

- strong equity buffer/staying power with $2.6 B equity, $2 B debt and $1 B cash

- earnings power $500 M and MC $4 B = P/E 8

- $900 k fully provided DTA

- P/BV=1.4

 

RYL

- reasonable equity buffer/staying power $540 M equity, $900 M debt, $600 M cash

- earnings power $200 M and MC $750 M = P/E 3.5!!!!!

- P/BV = 1.4

- $250 M fully provided DTA

 

PHM

- reasonable equity buffer/staying power with equity $2 B, debt $3.4 B and cash $1.4 B

- earnings power of $500 M and MC $3 B = P/E 6

- owns $3 B land, entitled land might get scarce and takes time to develop, looks like a good competitive advantage

- $2 B fully provided DTA

- P/BV= 1.7

 

LEN

- reasonable equity buffer/staying power, $3 B equity, $3 B debt, $1 B cash

- earnings power $600 M and MC $3.5 B = P/E 6

- $1 B fully provided DTA

- P/BV= 1.3

- earnings from Rialto distressed real estate investment fund

 

NVR

- incredible ROA & ROE 2001-2005

- earnings power $350 M and MC $4.4 B = P/E 12

- P/BV=2.4   expensive……

- no losses during housing crisis???

 

BZH

- cheap but no equity buffer/no staying power

 

KBH

- cash $800k, debt $1.8 B, equity $440k

- high leverage, minimal equity buffer in case housing doesn’t recover soon

- very cheap based on earnings power of $300 M and MC $750= P/E 2.5!!!!!!

- too risky……..

 

TOL

- earnings power $250 M and MC $3.5 B = P/E 14, too expensive……

 

 

 

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buffett has repeatedly stated that it is only a matter of time for construction to rebound with family formations > 1 million and new starts < 500k

 

since the sector is clearly out of favor, there might be some interesting opportunities here...

 

most home builders that are still around have adjusted their business models to current economic reality and operate at break even levels at a fraction of the peak years activity....

 

an "orientational dive" in the sector yields the following quantitative information, feedback and qualitative comments would be highly appreciated.....

 

the companies are ranked from strong to weak (financial staying power), i used average 2001-2004 earning to estimate earnings power, knowing that this method is far from accurate but represent, i hope, a conservative valuation approach

 

MDC

- very strong equity buffer/staying power, $1 B equity, $1 B debt, $1 B cash

- earnings power $200 M and MC $1.2 B = P/E 6

- Whitman sold in 2010 with significant loss????

- $200 M fully provided DTA

- P/BV= 1.2

 

DHI

- strong equity buffer/staying power with $2.6 B equity, $2 B debt and $1 B cash

- earnings power $500 M and MC $4 B = P/E 8

- $900 k fully provided DTA

- P/BV=1.4

 

RYL

- reasonable equity buffer/staying power $540 M equity, $900 M debt, $600 M cash

- earnings power $200 M and MC $750 M = P/E 3.5!!!!!

- P/BV = 1.4

- $250 M fully provided DTA

 

PHM

- reasonable equity buffer/staying power with equity $2 B, debt $3.4 B and cash $1.4 B

- earnings power of $500 M and MC $3 B = P/E 6

- owns $3 B land, entitled land might get scarce and takes time to develop, looks like a good competitive advantage

- $2 B fully provided DTA

- P/BV= 1.7

 

LEN

- reasonable equity buffer/staying power, $3 B equity, $3 B debt, $1 B cash

- earnings power $600 M and MC $3.5 B = P/E 6

- $1 B fully provided DTA

- P/BV= 1.3

- earnings from Rialto distressed real estate investment fund

 

NVR

- incredible ROA & ROE 2001-2005

- earnings power $350 M and MC $4.4 B = P/E 12

- P/BV=2.4   expensive……

- no losses during housing crisis???

 

BZH

- cheap but no equity buffer/no staying power

 

KBH

- cash $800k, debt $1.8 B, equity $440k

- high leverage, minimal equity buffer in case housing doesn’t recover soon

- very cheap based on earnings power of $300 M and MC $750= P/E 2.5!!!!!!

- too risky……..

 

TOL

- earnings power $250 M and MC $3.5 B = P/E 14, too expensive……

 

 

 

 

Why pay more than book for a commodity business with absolutely no barrier to entry, especially when there are better businesses that might benefit from normalization of construction?  Home builders that survived the late 80's and early 90's real estate recession barely scraped by for many years until prospects improved around Y2K.

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several home buiders are trading slightly over tangible book value while this book value will rapidly and significantly increase when housing turns around

 

does anyone have examples of construction related businesses with moats that are trading below book value?

 

USG would be one such company, however it is trading at 2.6 x BV and has a weak equity buffer/staying power with equity $540 k, debt $2.3 B and cash $600, imagine it takes 2-3 more years for housing to turn around, USG would suffer from strong dilution in this scenario while some of the home builders operate at break even now with decent liquidity positions...

 

regards

rijk

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Another data point is the 8 to 9 million home overhang which will take 16 to 18 years to work through at the 500k/year supply/demand imbalance.

 

Packer

 

300,000 homes destroyed per year in addition to 1.2m average new household creation (1.2m is what I read somewhere).  So that would be 1.5m home demand versus just 300,000 currently being built per year.

 

1.2m per year deficit takes only 7 years to blow through "8 or 9 million home overhang", less that 1/2 of the estimated 16 to 18 years.

 

Where did the number "8 or 9 million" come from?  During the housing bubble there were never that many homes built in excess of demand.  Is this based on a forecast that jobs never come back and/or get worse?

 

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"The long-term demographic need for new housing in the United States is approximately 1.5 million new units per year, according to the Harvard Joint Center for Housing Studies."  

Total Housing Starts:

1998 1,616.9

1999 1,640.9

2000 1,568.7

2001 1,602.7

2002 1,704.9

2003 1,847.7

2004 1,955.8

2005 2,068.3

2006 1,800.9

2007 1,355.0

2008 905.5

2009 554.0

2010 586.9

 

As always Warren is probably going to be right give or take 3-6 months :)

 

According to usg, a typical house built for 100k has about 20k worth of materials and 80k worth of labor...makes sense why he thinks we'll be back to 6% unemployment in a few years.

 

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The 8 to 9 million is from Mort Zuckerman with 3 million (in some form of foreclosure/deliquency), 3 million (homes folks will eventally default - stragetic default) and 3 million (empty homes).  Even with a 900k per year excess demand it still takes 10 years.

 

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300,000 homes destroyed per year in addition to 1.2m average new household creation (1.2m is what I read somewhere).  So that would be 1.5m home demand versus just 300,000 currently being built per year.

 

Sorry if I'm being thick, but do 300k homes actually get bulldozed (otherwise destroyed) each year in the U.S.? 

 

 

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The 8 to 9 million is from Mort Zuckerman with 3 million (in some form of foreclosure/deliquency), 3 million (homes folks will eventally default - stragetic default) and 3 million (empty homes).  Even with a 900k per year excess demand it still takes 10 years.

 

Packer

 

1)  They all still need a housing unit to live in.  It sort of doesn't matter whether or not they are the owner.  It's still a household.

2)  Housing overhang figure is being magnified by the jobs environment.  You are not making allowance for any jobs recovery.  

 

So I think you're just counting the wrong thing.  Instead, I believe it just makes more sense to look at the housing formation growth of the last 10 years versus the amount of housing units built (less those destroyed).  That's the only true overhang. This other stuff is noisy distortion coming from jobs picture and people who cannot afford their payments (but they can afford to rent, so they will still occupy a unit of housing stock).

 

The pipeline of people who either are forced to sell or simply wish to default strategically -- this may push housing prices down, but that's completely irrelevant when it comes to how many households were formed in the past 10 years versus how many net housing units were built.  A person who wishes to strategically default isn't planning on living in a tent.  

 

 

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Think  hurricane or tornado or fire or flood.  How many were wiped out this year alone?

 

Also...

 

Every now and then an old house is torn down for various reasons.  Perhaps the house was tiny and outdated and the buyer bought it for the large lot in a good location.  Or a developer bought it for redevelopment.

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this is a good article on potential housing opportunities

 

stil haven't come accross a construction related company with moat that is currently trading below book value........

 

regards

rijk

 

http://investing.kuchita.com/2011/07/12/some-thoughts-about-housing-and-the-market/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+TheIntelligentInvestorBlog+%28The+Intelligent+Investor+Blog%29&utm_content=Google+Reader

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I agree they need a place to live but if they live in an apartment or with their parents that does not increase the demand for SFRs.  The SFR supply is what will drive the recovery Buffett is talking about.  As to jobs I think a "new normal" slow growth scenario is what we are looking at today.  I think this also happened after the last recession in 2002 but most folks did not heed and piled debt on as if we were coming out of a normal recession. 

 

In terms of destroyed homes, most of the destruction comes in areas of lower than average income many of which are probably not insured (New Orleans), therefore, in cases the homes do not get replaced.  Another aspect is the regional nature of the overbuild and the mortgage paperwork delays that only prolong the market clearing process.  I would bet on commercial rebound long before a resi one in the overbuild areas.

 

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I agree they need a place to live but if they live in an apartment or with their parents that does not increase the demand for SFRs.  The SFR supply is what will drive the recovery Buffett is talking about.  

 

I think this is where you come to the different conclusion from myself and Buffett.  I don't see a reason why a strategic defaulter is going to want to move in with Mom/Dad, or go to an apartment.  This is merely somebody who bought too high and doesn't want to pay off the mortgage.  They haven't said "I hate all this space, I want to put all of my furniture filling this huge house into a cramped apartment".  You're putting those words in their mouths and I can't see why.  They can just rent a SFR and they achieve their goal of strategic defaulting.  Same goes for people who bought at the top and cannot afford the mortgage -- rents on SFRs instead of their mortgage payments will likely cut their monthly cash outlay in half, so why this belief that they would prefer the cramped space of an apartment all of a sudden?  Lastly, there aren't 8 or 9 million vacant apartments.

 

This is an affordability issue in addition to a preference issue.  The preference is for the larger space... if they can still afford it.  These are people who once made the leap from an apartment to an SFR... presumably because of the benefits relative to an apartment.  Why do you have the assumption in place that most of these 8 million can't even afford rent on an SFR?  Do you have data on that?  I think we can safely assume that SFR rents are significantly cheaper than their troubled mortgages from a current cash flow perspective... to argue that it won't provide enough relief we need data showing that.

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Even if you pull out the 3 million strategic defaults you still have 6 years of supply overhang.  I think the market will recover but not in the next year or two.

 

Packer

 

That 6 years of overhang again assumes they all go back to apartments.  As jobs come back (if they do), some of these people won't need to be in foreclosure in the first place or will be able to rent an SFH again.  Family with two income earners can't afford the payments today with one laid off, but when he gets his job back in construction related industry they can once again suddenly afford it.  Somebody has to build those 6 million apartments (and all the rest of the jobs that construction drags along with it).

 

I don't see why again a person losing a house with a $2,500 monthly mortgage is assumed to not be able to rent it from the next owner for $1,250.  You are tossing all of these people into the apartment pile.  They have children, they have furniture, they believe they need more space and quite likely can afford more space if monthly payments cut in half.

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I think residential construction will be the key to a number of things moving forward. Both Buffett and Calculated Risk feel that construction will be the ket to future GDP; once it picks up then GDP and employment will improve.

 

A couple of plays I am paying more attention to are the two large Canadian lumber producers: West Fraser (WFT.TO) and Canfor (CFP.TO). Both players are very efficient producers and should profit in a big way once conditions improve. They also have low debt. Something to also consider is the pine beetle issue in central BC; in a couple of years we could see the allowable cut shrink at the same time housing in the US picks up. Falling supply and rising demand = very large price increases = very profitable for WFT and CFP.

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I think residential construction will be the key to a number of things moving forward. Both Buffett and Calculated Risk feel that construction will be the ket to future GDP; once it picks up then GDP and employment will improve.

 

A couple of plays I am paying more attention to are the two large Canadian lumber producers: West Fraser (WFT.TO) and Canfor (CFP.TO). Both players are very efficient producers and should profit in a big way once conditions improve. They also have low debt. Something to also consider is the pine beetle issue in central BC; in a couple of years we could see the allowable cut shrink at the same time housing in the US picks up. Falling supply and rising demand = very large price increases = very profitable for WFT and CFP.

The story is better than that, West Coast producers now have another mkt to sell into... China. China built basically zero homes out of sticks now they are buying a good and rapidly growing portion of our out put. The US economy will start to create jobs when they build new houses and new cars there is no US economy without those two industries.
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buffett has repeatedly stated that it is only a matter of time for construction to rebound with family formations > 1 million and new starts < 500k

 

since the sector is clearly out of favor, there might be some interesting opportunities here...

 

most home builders that are still around have adjusted their business models to current economic reality and operate at break even levels at a fraction of the peak years activity....

 

an "orientational dive" in the sector yields the following quantitative information, feedback and qualitative comments would be highly appreciated.....

 

the companies are ranked from strong to weak (financial staying power), i used average 2001-2004 earning to estimate earnings power, knowing that this method is far from accurate but represent, i hope, a conservative valuation approach

 

MDC

- very strong equity buffer/staying power, $1 B equity, $1 B debt, $1 B cash

- earnings power $200 M and MC $1.2 B = P/E 6

- Whitman sold in 2010 with significant loss????

- $200 M fully provided DTA

- P/BV= 1.2

 

DHI

- strong equity buffer/staying power with $2.6 B equity, $2 B debt and $1 B cash

- earnings power $500 M and MC $4 B = P/E 8

- $900 k fully provided DTA

- P/BV=1.4

 

RYL

- reasonable equity buffer/staying power $540 M equity, $900 M debt, $600 M cash

- earnings power $200 M and MC $750 M = P/E 3.5!!!!!

- P/BV = 1.4

- $250 M fully provided DTA

 

PHM

- reasonable equity buffer/staying power with equity $2 B, debt $3.4 B and cash $1.4 B

- earnings power of $500 M and MC $3 B = P/E 6

- owns $3 B land, entitled land might get scarce and takes time to develop, looks like a good competitive advantage

- $2 B fully provided DTA

- P/BV= 1.7

 

LEN

- reasonable equity buffer/staying power, $3 B equity, $3 B debt, $1 B cash

- earnings power $600 M and MC $3.5 B = P/E 6

- $1 B fully provided DTA

- P/BV= 1.3

- earnings from Rialto distressed real estate investment fund

 

NVR

- incredible ROA & ROE 2001-2005

- earnings power $350 M and MC $4.4 B = P/E 12

- P/BV=2.4   expensive……

- no losses during housing crisis???

 

BZH

- cheap but no equity buffer/no staying power

 

KBH

- cash $800k, debt $1.8 B, equity $440k

- high leverage, minimal equity buffer in case housing doesn’t recover soon

- very cheap based on earnings power of $300 M and MC $750= P/E 2.5!!!!!!

- too risky……..

 

TOL

- earnings power $250 M and MC $3.5 B = P/E 14, too expensive……

 

 

 

 

Why pay more than book for a commodity business with absolutely no barrier to entry, especially when there are better businesses that might benefit from normalization of construction?  Home builders that survived the late 80's and early 90's real estate recession barely scraped by for many years until prospects improved around Y2K.

 

Well, you better look at NVR's performance to understand why it is trading at a premium to BV. I had the chance to buy it

@ a little over 100, but wonder why I did not pull the trigger. There is a writeup on VIC in detail, it will be of tremendous help to understand the business.

 

Some of the best investments were discovered in a lousy business. NVR is one of them. If we have the bias towards certain categories, we would never undercover those gems.

 

 

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NVR sure was a good investment, their success seems to be related to using option contracts to buy land vs direct buying and pre-selling versus keeping inventories...

 

this is the past, what's relevant now is the future, how durable are NVR's competitive advantages?

 

having listened to several conference calls, it sounds like other builders are moving towards using more options to buy land and more pre-selling versus speculation.....

 

so the "durability" might be in question, additionally, what used to be a competitive advantage in a down market might turn out to be a disadvantage in a recovery, example, PHM's $3 B land might become a competitive advantage once the cycle turns, availability shrinks and conversion from raw land to finished lots takes 1-2 years

 

regards

rijk

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buffett has repeatedly stated that it is only a matter of time for construction to rebound with family formations > 1 million and new starts < 500k

 

since the sector is clearly out of favor, there might be some interesting opportunities here...

 

most home builders that are still around have adjusted their business models to current economic reality and operate at break even levels at a fraction of the peak years activity....

 

an "orientational dive" in the sector yields the following quantitative information, feedback and qualitative comments would be highly appreciated.....

 

the companies are ranked from strong to weak (financial staying power), i used average 2001-2004 earning to estimate earnings power, knowing that this method is far from accurate but represent, i hope, a conservative valuation approach

 

MDC

- very strong equity buffer/staying power, $1 B equity, $1 B debt, $1 B cash

- earnings power $200 M and MC $1.2 B = P/E 6

- Whitman sold in 2010 with significant loss????

- $200 M fully provided DTA

- P/BV= 1.2

 

DHI

- strong equity buffer/staying power with $2.6 B equity, $2 B debt and $1 B cash

- earnings power $500 M and MC $4 B = P/E 8

- $900 k fully provided DTA

- P/BV=1.4

 

RYL

- reasonable equity buffer/staying power $540 M equity, $900 M debt, $600 M cash

- earnings power $200 M and MC $750 M = P/E 3.5!!!!!

- P/BV = 1.4

- $250 M fully provided DTA

 

PHM

- reasonable equity buffer/staying power with equity $2 B, debt $3.4 B and cash $1.4 B

- earnings power of $500 M and MC $3 B = P/E 6

- owns $3 B land, entitled land might get scarce and takes time to develop, looks like a good competitive advantage

- $2 B fully provided DTA

- P/BV= 1.7

 

LEN

- reasonable equity buffer/staying power, $3 B equity, $3 B debt, $1 B cash

- earnings power $600 M and MC $3.5 B = P/E 6

- $1 B fully provided DTA

- P/BV= 1.3

- earnings from Rialto distressed real estate investment fund

 

NVR

- incredible ROA & ROE 2001-2005

- earnings power $350 M and MC $4.4 B = P/E 12

- P/BV=2.4   expensive……

- no losses during housing crisis???

 

BZH

- cheap but no equity buffer/no staying power

 

KBH

- cash $800k, debt $1.8 B, equity $440k

- high leverage, minimal equity buffer in case housing doesn’t recover soon

- very cheap based on earnings power of $300 M and MC $750= P/E 2.5!!!!!!

- too risky……..

 

TOL

- earnings power $250 M and MC $3.5 B = P/E 14, too expensive……

 

 

 

 

Why pay more than book for a commodity business with absolutely no barrier to entry, especially when there are better businesses that might benefit from normalization of construction?  Home builders that survived the late 80's and early 90's real estate recession barely scraped by for many years until prospects improved around Y2K.

 

Well, you better look at NVR's performance to understand why it is trading at a premium to BV. I had the chance to buy it

@ a little over 100, but wonder why I did not pull the trigger. There is a writeup on VIC in detail, it will be of tremendous help to understand the business.

 

Some of the best investments were discovered in a lousy business. NVR is one of them. If we have the bias towards certain categories, we would never undercover those gems.

 

 

 

Realize that homebuilders are merely vehicles for speculating in land.  Over the very long cycle, they don't come close to making their cost of capital on the construction part of their business, although this part of their business was profitable during the bubble years.  The only reason most residential builders are still in business is the massive stimulus.  

 

Generally, the only builders that do OK over the long cycle are those that got started at the very bottom or the very few that still have enough resources to acquire land for pennies on the dollar near the bottom of the cycle.   A few builders like NVR that have land in development constrained areas may be better off than most builders who may not have accurately marked all their land to current market value.

 

The problem with the idea that this is a great time to buy homebuilders is that the opportunity is in reality only so so because the stimulus did not allow the residential real estate market to reach a market clearing floor price.  Even now at what seems to be near the bottom, prices are still not quite back to the long term trend line.  This limits the upside, compared to the  last two deep US residential real estate cyclical bottoms in the 1970's and early 90's.

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NVR sure was a good investment, their success seems to be related to using option contracts to buy land vs direct buying and pre-selling versus keeping inventories...

 

this is the past, what's relevant now is the future, how durable are NVR's competitive advantages?

 

having listened to several conference calls, it sounds like other builders are moving towards using more options to buy land and more pre-selling versus speculation.....

 

so the "durability" might be in question, additionally, what used to be a competitive advantage in a down market might turn out to be a disadvantage in a recovery, example, PHM's $3 B land might become a competitive advantage once the cycle turns, availability shrinks and conversion from raw land to finished lots takes 1-2 years

 

regards

rijk

 

I remember when people asked on the VIC why other home builders have not imitated NVR's strategy since it was so obvious, the answer was people and execution. The most durable competitive advantage is always the human assets. NVR builds when the sale is closed; others build and hope people will come. It is true when things look bright at the bottom, asset-heavy builder should do better. But I believe over time, builders like NVR will do way better simply because they only build to sell, which results in a light-asset model. This is the key difference between the two kinds of builders. However, this is only my opinion, and I am not even familiar with the home-building business although I read a lot about NVR.

 

In NVR and AAB's case, I do not believe we should draw a conclusion too early on whether it should sell at a premium or discout to their book value. It is dangerous to assume that AAB or NVR should trade at a discount to BV simply because its peers are trading at a discount. We talked a lot about bias here, and certainly this is one of them. I could be proved wrong in the end, but I do not want to commit an opinion well before I did my homework.

 

I purchased AMA.ax at 4.4 cents last year and am buying more of it recently. The funny thing is that I did not know there are lots of stocks in AU are penny stocks. So when I started from "A", this is one of the first stocks I looked at. If I surrendered to my natural dislike about penny stocks, I would have missed one of the best investments in terms of IRR in my life. Fortunately, I forced myself to read through the annual reports, and that aroused my interests. In fact, it is so easy to figure out that a beginner can tell you this is a no brainer.

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  • 2 weeks later...
  • 4 weeks later...

what a difference a month makes, several home builders are now trading below bv and at low single digit p/e (based on pre bubble normalized earnings power)

 

phm p/bv 0.75 p/e 3

len p/bv 0.74 p/e 4

ryl p/bv 0.8 p/e 2

mdc p/bv 0.8 p/e 4

tol p/bv 0.96 p/e 10

dhi p/bv 1.1 p/e 6

 

buffett talks about excess housing inventory of only 1 million and a recovery by mid 2013

 

http://www.charlierose.com/view/interview/11845

 

based on current economic conditions and outlook, it might be wise to pick "the last one standing" any suggestions?

 

regards

rijk

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