Looking for the cheapest stocks on the market right now? Two sectors stand out: homebuilders and steelmakers.
Barrons selected for the 10 actions of the
S&P Midcap 400 and S&P Smallcap 600 with the lowest price-to-earnings ratios based on projected 2022 earnings, using consensus estimates from FactSet. Of the group of 30 stocks across the three indexes, 14 were homebuilders and steel producers, all trading for just two to four times this year’s estimates. Many home builders also negotiate around book value.
The common denominator for both groups is that investors don’t believe the currently robust earnings will last. Stocks factor in disastrous downturns for both industries that are unlikely to materialize. Home building inventories have fallen 40% or more this year.
The losses in stocks of homebuilders and steel mills reflect a large pullback in economically sensitive stocks. Yet balance sheets have rarely been stronger for these industries, providing a financial cushion in the event of a potential recession.
While a doubling of mortgage rates to 6% reduces housing demand, a prolonged and deep downturn seems unlikely, given strong demographic trends and limited supply. “Homebuilders are pricing in an Armageddon scenario and a repeat of the Great Financial Crisis when home prices fell 30%,” says Evercore ISI housing analyst Stephen Kim. “Equities are cheap and more than offset the risk.”
Kim thinks they could double next year.
Bespoke Investment Group noted last week that the 40% decline in home building stocks from their previous highs marked the sixth such decline in the last three decades. The average one-year gain from these declines was 43%, with the only negative result being in 2006.
Homebuilder profits remain at record highs, as seen in
(symbol: LEN) latest quarterly report. Lennar is the second largest homebuilder in the United States behind
(DHI). Lennar acknowledged the market was softening, but Chairman Stuart Miller said the land write-downs, which hammered homebuilders during the 2008 financial crisis, were unlikely unless the market fell “dramatically”. That reassured analysts and investors, and Lennar rallied, gaining 8%.
At around $70 per share, Lennar is trading at four times expected 2022 earnings and below its book value of $74 per share. Lennar and other automakers have stepped up stock buybacks and increased dividends this year.
Wedbush analyst Jay McCanless says stocks are trading on average at just 80% of tangible year-end 2022 book value. Builders are benefiting from growing demand from companies renting single-family homes.
|Company/Title||Recent Price||Change since the beginning of the year||2022E EPS||2022E PE||2023E P?E||Dividend yield||Price/Book||Market value (bil)|
|DR Horton / DHI*||$64.08||-41%||$17.14||3.7||4.0||1.4%||1.3||$22.6|
|Lennar / LEN**||67.66||-42||16.86||4.0||4.3||2.2||1.0||19.6|
|Toll Brothers / TOL***||42.41||-41||10.22||4.2||3.8||1.9||0.9||4.9|
|Cleveland Cliffs / CLF||$16.27||-25%||$5.77||2.8||4.4||None||1.4||$8.5|
|Nucor / NUE||107.84||-6||26.36||4.1||8.4||1.9%||1.9||28.7|
|Stelco Holdings / STZHF||26.34||-19||11.62||2.3||5.9||3.6||1.6||1.9|
|Steel Dynamics / STLD||67.40||9||20.37||3.3||6.3||2.0||1.8||12.7|
|American Steel / X||19.07||-20||10:20 a.m.||1.9||5.4||1.1||0.5||5.0|
*Seven. year-end, **Nov. end of fiscal year, ***Oct. end of year, E=Estimate
McCanless favors Horton, which generated an outrageous return on equity of 34% in the year ended March. Horton shares, at $67, trade for four times earnings.
McCanless says high-end homebuilders may be better protected from rate hikes because of their affluent clientele. It favors small-cap builders
Tri Pointe Homes
(TPH), which is now trading around $16, three times 2022 earnings. The luxury leader,
(TOL), is trading around $44, four times estimated 2022 earnings and below book value of $46 per share. About 20% of toll buyers don’t need a mortgage; they pay cash.
Steel stocks are among the most volatile. Companies have generally posted record results in the first quarter and have been guided towards similar performance in the current quarter.
Still, stocks were hammered by recession fears as steel prices, as measured by hot-rolled steel coils, fell below $900 a ton from $1,500 earlier this year. . Steelmakers should still generate significant profits at current prices, suggesting that the risk/reward ratio is attractive.
Alan Kestenbaum, CEO of a Canadian steelmaker
(STZHF), says the steel market is getting “very tough. Prices have come down every week.
The demand outlook is good. The automotive industry, which accounts for 25% of U.S. steel demand, is operating below capacity due to chip shortages and could increase production in 2023. Other key users of steel, including infrastructure and energy, are also in good shape. A positive sign is industry consolidation. Four producers now account for more than 80% of steel production in the United States.
(X), at $19, trades for less than twice 2022 earnings. The company’s plan to build a big new “mini-factory” for around $3 billion hasn’t gone down well with some investors, who would like to see more cash returned to shareholders.
(CLF), another large integrated steel producer, has no big expansion plans and has a shareholder-focused CEO in Lourenco Goncalves. Its stock, at $16, is trading at three times forecast earnings for 2022.
(NUE), at $107, is trading for four times earnings and yielding almost 2%. It has an attractive business mix, but its capital allocation is questionable after recently agreeing to pay $3 billion for a garage door maker at a huge premium to its own valuation.
(STLD), which, like Nucor, operates mini-plants using scrap metal as an input, completed a major new plant in Texas this year. Its shares are trading at $66, three times earnings.
Stelco operates a lucrative blast-furnace plant in Ontario and may have the most investor-oriented CEO of the bunch in Kestenbaum. Stelco has increased its dividend several times and bought back a lot of shares. The stock, at around $26, is yielding 3.6% and yielding only twice the estimated earnings for 2022.
Ultra cheap stocks can offer nice upside potential and a margin of safety. Home builders and steel are eligible.
Write to Andrew Bary at [email protected]