Mr. Campbell: During the first six months of that period, the stocks performed extremely well from a price performance perspective, driven by solid financial results, as well as by extremely compelling valuations relative to historical levels. In February 2000, when the recent rally began to gain momentum, the group was trading at roughly 5 times forward EPS estimates and, in several cases, 20%-25% below book value. Given the sector's historically low valuations, rising earnings estimates and the perception of a declining interest rate environment, investors flocked to the group as the year progressed. On average, the group rose approximately 80% in 2000. We estimate 75% of the increase was a function of multiple expansion, with rising EPS estimates accounting for the balance. Since January 1, we've been pleasantly surprised at how well housing activity has held up in the face of declining economic fundamentals, especially falling consumer confidence and rising unemployment. I think that's a testament to not only the favorable demand/supply relationship in the overall market, but also to several unique dynamics and secular shifts that have been taking shape in the sector for the last five years or so. Unlike 2000, a majority of the price movement thus far in 2001 appears to be earnings-related versus multiple expansion.
TWST: Carl, which companies stand out as you review the performance of
the group through the second half of 2000 and in 2001 year to date?
Mr. Reichardt: From a price appreciation standpoint, we've been
surprised at how well the smaller capitalization companies have done
relative to the larger cap companies. As consolidation in the industry
becomes a bigger, more important theme, some of the small caps have run
up on speculation that they may be acquired by larger builders. In
addition, I think the law of large and small numbers is helping them as
well, as some of the smaller companies have easier growth comparisons
than the larger companies do. One of the things that we've noticed is
the valuation disparity among the companies that have a focus on the
California markets relative to others. In some cases, though not
necessarily all, you can tie less-than-robust performance of the stocks
on a year-to-date basis to the concerns about the California economy
generally, which I think are overblown to a certain extent. In terms of
earnings performance, for the last 11 quarters, homebuilders that are
covered by three or more sell siders have outperformed First Call mean
EPS expectations by an average of about 13% each and every quarter. That
type of performance in this market environment is obviously intriguing.
And I think you're likely to continue to see earnings expectation
outperformance for the next few quarters at least, perhaps not to the
same degree, but relative to other equity investments I think that's
powerful.
Tickers included in this excerpt: BZH, CROS, CTX, DHI, HOV, KBH, LEN, MDC, PHM, RYL, SPF, TOL
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