Monday, July 9, 2012

TOL: New homes for sale

Google searches for homes have been on the rise the past week, a phenomenon that over the weekend sent me on a cruise through the stock tickers looking for profitable trades before I realized that Katie's and Tom's marital problems and divorce were the source of the searches. (Good luck, you two!)


(And BTW, googlers: It's Katie Holmes, not Homes. But whatever.)

New home sales are still falling, two years into the recovery from the Great Recession. They typically peak in the 2nd quarter each year, and 2nd quarter sales have been in a downtrend since the economy hit bottom in 2009.

All of which makes the chart for Toll Brother Inc. (TOL) a bit of curiosity. Toll Brothers makes new luxury homes, from the capital's Virginia suburbs through Austin and Las Vegas all the way to San Jose, Toll Brothers has new homes for sale.

The company's stock hit a recession low of $13.16 in October 2011, far later than most companies, and has since risen steadily to last week's high of $30.41.

In the near term, TOL began a rapid rise, including two upside gaps, from $25.67 on June. 26. The rate of increase moderated last week, and the last three days have shown a sideways trend.

If it's always darkest before the dawn -- and certainly the public mood is as dark as any I've seen since the early 1980s Paul Volcker recession -- then perhaps TOL's uptrend is the first harbinger of dawn.

Toll Brothers has return on equity of 3%, which I find remarkable given how hard the new homes market was hit in the recession. Long-term debt amounts to 74% of equity.

The company reported three years of annual losses through 2010 (the company's fiscal year ends on Oct. 31), and then returned a profit in 2011.

Two out of the three quarters of the current fiscal year have shown profits and upside surprises.

Institutions own 82% of shares, and the price has been bid up to quite an expensive level. It takes $3.33 in shares to control a dollar in sales.

I don't normally track the price/earnings ratio, but I'll note that TOL's, at 72.76, is well above others in its sector (construction services).

All of this priceyness can be taken two ways. A long-term value trader of the Warren Buffett school will declare TOL to be overpriced. A shorter-term momentum trader -- that describes me -- will take those multiples as a vote of confidence in future growth, and therefore future gain in the stock price.

On the other hand, my analyst enthusiasm index for TOL has dropped over the past month, from a positive 6% down to a negative 7%. (The index gives positive weighting to strong buys, ignores buys, and negative weighting to holds, sells and strong sells.)

So the question is whether the market is leading the analysts or vice versa.

A leading aggregator of analyst opinion, Zacks, last week highlighted TOL in its public newsletter as an aggressive growth pick, and today did the same with another homebuilder, RYL. I haven't read either Zacks write-up yet, to keep my own analysis independent. You can read the TOL report here and the RYL report here.

Zacks' analysis is driven by algorithms, but its decision to highlight the home construction sector was a human choice.

TOL on average trades 4.1 million shares a day, supporting a wide selection of option strike prices with high open interest and narrow bid/ask spreads.

Option volume is running below its five-day moving average, with puts having a slight edge on calls.
Stock volume hs also declined steadily during the run up that began in late June.

Implied volatility stands at 38%, in the lower half of the six-month range. It has fallen precipitously from mid-June.

Options are pricing in confidence that 68.2% of trades over the next month will fall between $26.77 and $33.29 for a maximum gain or loss of 11%.

The stock is trading at the upper edge of the five-day fair-trading range, which encompasses 68.2% of trades surrounding the most traded price of that period, $29.79. The range runs from $29.45 to $30.02.

Toll Brothers next publishes earnings on August 21.

Decision for my account: There's a lot to like about TOL, not least of which is that its earnings are beyond expiration of the August options. With the 2nd quarter earnings season kicking off today, it will be hard for awhile to find stocks without earnings announcement looming.


The fact that the near-term uptrend has paused, and today's price is showing a hesitation pattern, suggests waiting before opening a position. A break above the $30.41 high would suggest resumption of the uptrend, and below $29.43 would suggest the uptrend is over. I'll wait a day or two of trading before making a decision.


If I do trade TOL, it will be as a bull put vertical spread expiring in August. If I were trading today, I would set it up as short the $29 strike and long the $27, for a potential 10% profit and a 3:1 risk/reward ratio. The position would be profitable down to about $28.50 on the stock price.

Disclaimer
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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