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You Won't Believe What Sector I Want You to BuyBy Frank Curzio, editor, Small Stock SpecialistMonday, March 15, 2010 Washington D.C. screwed taxpayers... again.
After providing $180 billion to bail out AIG and $125 billion to prop up Fannie Mae and Freddie Mac (money taxpayers may never get back), Obama just gave billions of dollars in handouts to homebuilders.
These handouts come in the form of enormous new tax breaks, just signed into law last year. The tax breaks allow homebuilders to offset losses incurred in 2008 and 2009 against profits booked in the past five years. Previously, homebuilders were allowed to offset losses against just two years of profits.
In short, a homebuilder that paid a huge amount in taxes during the boom years from 2004 to 2006 can now actually get a refund (tax credit) against its losses in 2008 and 2009. This bizarre development means homebuilders are pulling money out of the tax pool from a few years ago and placing it back on their books.
If you haven't heard of this tax change, you're with most Americans. It was secretly added into the Worker, Homeownership and Business Assistance Act of 2009. That law extended unemployment benefits by 20 weeks and renewed the first-time homebuyer credit. Homebuilders are already reaping huge results...
On March 2, for example, builder Hovnanian reported it earned $236 million in its fiscal third quarter. It was Hovnanian's first profit since 2006. Analysts were expecting a loss of $319 million. The company saved $291 million from the tax break. This is an extraordinary difference between what Wall Street expected and what Hovnanian actually did.
Earlier this year, on February 6, builder KB Home reported a first-quarter profit of $48 million. Without the tax benefit, the homebuilder would have reported a loss of $53 million. The company saved $101 million from the tax break... almost 10% of its current market cap.
Hovnanian and KB Home are not alone...
Have a look at the chart below. It's a list of homebuilders and the amount of cash they received last quarter because of the law change. I also compared these profits to the net income for each homebuilder in the previous 12 months.
Sure, home inventory is high... Foreclosures are near record levels... And prices may come down farther... I get it.
But these homebuilders received hundreds of millions of dollars for free and are buying up land at rock-bottom prices.
I'm in the process of buying a home in Florida. I just locked in a 30-year fixed mortgage rate of 4.85% from Wells Fargo. While doing a walkthrough of the house with my real estate agent, her cell phone rang every five minutes. She said it's busy right now. Other real estate agents I spoke to over the past few weeks in other parts of the country echoed the sentiment.
Today's sales will be factored into results when homebuilders report earnings in May. I expect results to be strong... and I don't believe stock prices have factored in the coming (temporary) earnings surge from the first-time homebuyers tax credit and near-record-low mortgage rates.
There are several ways to play the homebuilder rally. You can buy individual stocks like DR Horton or Pulte, which have huge cash hoards. Another way is to purchase the SPDR S&P homebuilder fund. The symbol is XHB.
I suggest using patience on your entry. Stocks have run up over the past few weeks, so in the short term, they are overbought. You'll get a better price on this trade in a week or two.
Good trading,
Frank Curzio
Further Reading:
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