Tom A's Stock Picks

Homebuilders - dead cat bounce?

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Reading the WSJ today, or was it something online, I saw the recent rally in homebuilders described as a "dead cat bounce." That started me thinking about taking a quick profit on my SLO positions, which were added last week and have gone up 10% to 20% or more over the past few days. After all, the image doesn't portray anything that is going to last long or go far. And, as I write this, they are giving it back, down as much as 5% by midmorning.

The actual business operations of this group may not start recovering until 2009, from what I read, so the rally could be a little early. The Citigroup analyst who upgraded several of them recently noted that they usually go up well ahead of their fundamentals, as seems to be occurring now.

Most of them have taken large writeoffs of inventory and options on land, which has discouraged many investors and commentators, who are fearful that there will be more inventory writeoffs as the slowdown drags on. In a related situation, many banks are writing down assets related to sub-prime loans, leading to discussion of whether they are indulging in "big bath" accounting. Citigroup stock increased nicely in the wake of their horrendous earnings warning.

Certainly there is the opportunity to make writeoffs as big as possible. I wouldn't anticipate any resistance from auditors on something so financially conservative. Of course, when the low-priced inventory is sold in subsequent periods, profits will be that much larger. As a group, homebuilder managements seem to be fairly adroit in their timing, witness the sale of non-core assets last year, heavy insider selling at high points, the credit lines that were extended through 2011 or 2012 last year... Perhaps they are equally adroit at taking their losses at the best times.

If losses so far are of the big bath variety, from here on they should report modest profits and increasing cash, until the housing market starts to recover. Also, we will not be subjected to the "strip tease" which occurs when losses are reported over a period of time, rather than all at once.

All of this is speculation and conjecture. Where I would hang my hat is valuation, the homebuilders as a group are still trading at less than book. Also, the land, they are not making any more of it. I am planning to hold my positions, monitoring earnings in the expectation of seeing one large loss quarter (if it has not already occurred) followed by modest profits and increasing cash flows, with occasional small writeoffs. Any exceptions will need to be analyzed as they occur, with corrective action as needed.