Building Materials and Homebuilding Industries overvaluation and the role of the ETFs

A short article in this week's Barron's by Vito Racanelli (Jan 25 p. M5) prompted another look at two of the most expensive industries in our year end valuation.

Building Materials and Homebuilding were overvalued on average by 57% and 59% respectively and so far this month, they have outperformed the market.

D R Horton (DHR) is a good example of the extent to which the valuations are stretched beyond anything that their past history would support.

Analysis of DHR

DHR's estimate is $0.95 for this year but its normalized earnings are $1.29, an RoE of  14%. (Expressed as MPEPS, it is shown on the right hand side of this graph.)

Using its history of relative valuation, DHR would need to earn a normalized RoE (not peak!) of 31% or $2.82 (IEPS) a share and have an annual growth rate of 32%.  This has no precedence in the companies history except for a brief period in the early nineties when the company likely was very different than it is today.  The consensus estimates for 2014 is $1.35 which doesn't come close to what is needed.

This graph shows the calculated price range vs the actual High, Low and Close.

The performance test for this analysis is good.  The median return of the most expensive years is -7% pa relative to the S&P 500 while the median return for the most undervalued years is +35%.


Other stocks in this group, like LEN and KBH to name but two, are very similar to this picture.

One possible explanation that caught my eye in the Barron's piece, was the role played by ETF's which attract investment dollars to industries and sectors, presumably without the benefit of any valuation analysis.

This graph shows the dollar volume and its six month moving average of the purchases of the S&P Homebuilding ETF.

There was a surge in demand for this ETF starting in September of 2011.  It is very likely that that is part of the reason for this extraordinary opportunity in overvaluation.