Here is a blueprint for success in the stock market…
Find a company that has very strong long-term prospects and a stock price depressed by temporary near-term challenges.
Buy that stock now. Then, sit back and wait until the temporary issues subside and the stock rises as the much better long-term potential of the business emerges.
It is a very simple blueprint.
The challenge is finding a business where you are convinced that the challenges are truly short-term and the prospects for the long term are truly bright.
But now, I believe the economic and market upheaval COVID-19 has caused have made this challenge a little easier.
Homebuilders Have All the Components We Need
Homebuilders most certainly have short-term challenges. People have been locked in their houses, unemployment has skyrocketed like never before and nobody knows exactly when life will get back to normal.
In this environment, a lot of folks are not going to want to buy a new home anytime soon.
But it looks like some if not most of those challenges have been priced into the sector. Homebuilding stocks have fallen much more than the S&P 500 and Nasdaq 100 in 2020.
But this pandemic isn’t going to last forever. I can’t tell you specifically when economic activity will fully rebound, but eventually it will. It always does.
The American economy has been through world wars, housing crashes and terrorist attacks, and it always comes out the other side even stronger.
Remember, even the Spanish flu of 1918, which took 50 million lives, was followed by the Roaring ’20s.
When we do get past our current challenges, I believe investors will realize that American homebuilders actually have very strong long-term prospects.
A big part of my bullish long-term thesis for homebuilders can actually be attributed to our last crisis: the popping of the housing bubble.
Since the collapse in 2008, America has not been building nearly enough new homes.
New Homes Still Haven’t Rebounded
New home construction since the housing crisis is at its lowest level in 60 years.
From 1960 to 2008, the number of new homes built in the U.S. ranged from 1 to 2 per 100 households.
Since 2008, that number has been just 0.5 new homes per 100 households – roughly half the bottom end of the normal range.
Homebuilders were overly aggressive in the lead-up to the implosion of the housing bubble. Burned by that experience, the industry modified its behavior too far in the other direction.
In fact, it overadjusted so much that we are now looking at the creation of a new kind of housing crisis… not enough new homes!
Long term, this kind of problem is bullish for homebuilders.
According to Realtor.com, nearly 10 million new households have been formed in the United States since 2012. Meanwhile, only 5.9 million single-family homes have been built during that time.
Pent-up demand is growing, and there is not nearly enough housing supply to satisfy it.
Once we get past the COVID-19 crisis, it is going to require years of elevated levels of new homebuilding to catch up.
This is the exact blueprint we were looking for: a sector with short-term challenges and terrific long-term prospects.
But even better for these businesses, this shortage isn’t the only major macro force at play…
Low interest rates are also very good for homebuilders. Low rates mean low borrowing costs for homebuyers.
This obviously further increases levels of interest in buying a new home (and increases the prices buyers are willing to pay).
With the Federal Reserve’s double-barreled bazooka response to the COVID-19 crisis – which so far has involved slashing interest rates to zero and sending out trillions of dollars in stimulus – you can bet interest rates aren’t going higher anytime soon.
Short-Term Hurdles for Long-Term Profits
Realistically, 2020 and maybe even the first half of 2021 aren’t going to be banner times for homebuilders. But the longer-term earning power of the premier companies in this industry won’t be lessened by 18 months of lower earnings.
Once we get past this pandemic and the country gets fully back to work, the long-term setup for homebuilders is very attractive.
Here is the equation that I think these companies will be working with for the next decade…
Low Interest Rates + Shortage of Homes = Big Profits for Homebuilders
This is a sector I will be keeping my eye on in the coming months. I think we could see share prices drift lower in the near term as earnings results disappoint on the back of the economic slowdown.
That would create an even better long-term entry point to get into the very best operators in this business.