Build a Fortune with this Homebuilder

To risk, or not to risk: That is the question.
-Stephen Frankola, author Student Stocks blog.


The debate of risk versus reward is at the core of investment philosophy. Every investment, (even in something as seemingly-safe as a money market fund, as some investors may soon find out) is not without risk; determining the amount of risk versus potential profit determines whether investments are worth making.

I feel as though my following idea has unbelievable upside potential with little limited downside risk.

My company is Hovnanian, one of the troubled homebuilders, and my method is long-term options.

Today I purchased the super-long-term January 2010 calls at the $10 strike price. I picked up a contract at $3.60.

The stock is trading around $7.50 currently.

Here's the reasons why the options are such a great buy:

• I acknowledge that there is some chance that Hovnanian, (or any other homebuilder) could go bankrupt if the housing and credit markets crumble and the US economy enters into an extended recession. Therefore, the stock (and consequently, options) COULD go to $0. I think that the possibility of that is very slim, but if it does, you'll lose $350 with 1 options contract versus $750 with 100 shares of stock.
• The options don't expire for 25 months; by then, if the company is going to recover, it will have recovered. Theoretically, for an investor to break even, it just has to go back to $13.50 by January 22, 2010.
• The upside potential here is enormous. Hovnanian was a $70 stock at the peak of the housing bubble, at $40 within the past year, and at $13 less than a month ago. If the company doesn't go bankrupt (which, I'm betting it doesn't), this thing could easily be $20, 30, or even $40 depending on the size and pace of recovery.

Chart of Hovnanian 5-year stock price; courtesy of Yahoo! Finance

Homebuilding stocks will recover before the entire housing market does; someone who purchased his house within the past few years won't sell it next year for less than he payed. However, Hovnanian, which will be able to buy up cheapened land, can build new houses, sell cheaply, and turn a profit.


During the past quarter, Hovnanian took a huge loss writing down land, homes, and land options. I think that their books are already pretty sterilized; people already know how badly the housing market and homebuilders are doing.


So if Hovnanian's back to profitability in a year, you'll have a $15-25 stock with a year of time value left in your options. If it does bankrupt, you'll have lost less money than if you had purchased equity.


The prospect of making 200% or maybe 500% in two years while sacrificing little is an opportunity that should be seized. The worst may not yet be over for homebuilders, but I'm comfortable with the current risk-to-reward ratio.


Especially since there's a FOMC (Federal Open Market Committee) meeting on December 11th, there's a definite possibility for a quick pop. But my money says, in two years, homebuilders will have recovered significantly. If I'm right, the reward will be incredible.

Last Week Review

Last week was a very big week for me; my positions in my portfolio changed significantly.

I sold my long position in Hovnanian, as it was up 50% in three sessions, to a price that I felt was inflated. (So far, I was correct, as the price has fallen almost $2 from when I executed my sell order).

I was also long in some Hovnanian 12.5 September calls, which thankfully, I was able to sell for a nice little profit. I also had some Abercrombie 80 September calls, which I sold for a little more than break-even.

I'm looking to re-initiate a long position in a homebuilder at some point, once the market settles down a little bit - with earnings being reported from a couple builders this week, the potential volitility is a little more than I am comfortable with. I may or may not choose Hovnanian again; I might choose a safer play. as Hovnanian is probably one of more-endangered builders. However, I still do think HOV will not go bankrupt, and it will trade at two, three, or four times today's price, but I don't know if I want to reintroduce that risk to my porfolio now.

In other news, Syntax-Brillian (BRLC) finally bounced a little bit; I initiated long-term options position $2.50 calls, expiring January), increasing my exposure to the company with some deep-in-the-money, limited-risk calls.

Heelys (HLYS) also finally had a few positive sessions; once again, I reiterate that the company currently looks fundamentally cheap. It's a very long-term hold.

Now that I've pretty much eliminated all short-term plays from my portfolio... its time to get a new one! And for the first time in my life, I'm looking to go short and/or buy puts.

Look at the next post for what I'm thinking about.

Christmas in December: Fed Aftermath

Investors that held long positions as of 2:14 Tuesday should appreciate Mr. Bernanke's decisions. The interest rate cut catalyzed a rally that has now lasted two sessions and 3-4%.

I personally can thank him for some investing success. I had purchased September calls for Abercrombie (ANF) and Hovnanian (HOV) about a month ago, when they were both close to the respective strike prices (80 and 12.5). In the month, they were flat or down, and my options were going to expire worthless.

However, Mr. Bernanke came to the rescue and surprised the market with a 50 basis point cut. Both Abercrombie and Hovnanian shot up, and the contracts became in-the-money. (Interestingly, I half-jokingly predicted with almost 100% accuracy the Hovnanian gains; read my post here.)

Anyway, just because I should disclose this anyway, I sold my options in both Abercrombie and Hovnanian, and I sold my equity position in Hovnanian today with a well-executed stop-loss order. For the record, I still love the homebuilder's prospect's for the future; I will be looking for a lower reentry point sometime very soon. However, I feel the run-up to 15 was largely unmerited and a bit of a chain-reaction, so I'm currently waiting on the sidelines for things to settle down.

Thanks to Mr. Bernanke, my personal portfolio was up 10% on Tuesday, and I am now exactly even for the quarter. (Prior losses in Hovnanian, Syntax-Brillian, and others had hurt my performance).

Looking ahead, I am uncertain; the crystal ball that I used to predict the rally Tuesday is now out of commission. I watched Mad Money tonight for the first time in a while, and Cramer predicted that this is just the beginning of a huge bull market. I can't say that I agree with taht statement; with still-unresolved (and possibly still worsening) housing/credit problems in the United States and Europe, I don't think the world markets are financially sound enough to have an organic, fundamentally-based rally. The euphoria from the interest rate cuts may last a few more sessions, then people will probably start to profit-take.

My advice? Keep your eyes on the long-term prize. I'm long Toyota (it's the biggest position in my portfolio, at about 20% of assets). It is down a couple bucks from where I bought it in the middle of the summer, and frankly, I'm not too sure it's going to go up significantly anytime soon (due to the possibly-weakening economy, tight credit, etc). However, I'm 97% sure that in two or three years, based simply on fundamentals, Toyota could easily be a $200 stock.

Trying to profit from volatility is tempting, and if you succeed, congratulations. But if you look at the world's greatest investors - people like Warren Buffet - they seek out great values, and great companies, and reap great returns.

Fun Fantasy: Hovnanian

For a fun, lighthearted post, I'm going to make some far-fetched (bordering on ridiculous) speculations about the possibilities of movement in Hovnanian (HOV) share price in the next few days.

Wild Scenario 1:
Hovnanian trades flat in early trading tomorrow. At 2:30 tomorrow afternoon, the Fed announces that they are cutting interest rats by 50 basis points. Hovnanian is up 13% in the past two sessions and is still feeling the effects of the strong weekend sales. It immediately jumps 10%, along with the rest of the homebuilders, as well as the mortgage companies and entire financial industry in general. After this move to $12.50 or $13, shorts react to cover their positions to preserve gains from trades at $15, and the short squeeze propels the price higher. Hovnanian closes at $14, posting a 20% daily gain based on a chain reaction of good news and trading nuances.

Wild Scenerio 2:
The Fed keeps interest rates steady due to inflationary fears, disappointing the market. Hovnanian, having recently sold off lots of its inventory at a steep discount, falls back to $9 as the financial and homebuilding sectors crash.

Mild Scenerio 3:
The Fed cuts interest rates by 25 basis points, with language that implies that further cuts could cautiously be made in the future, depending on continuing economic circumstances. The market is flat, unimpressed by the cut but appeased by the wording.


DISCLAIMER: This was a fun little "what-if." But it is in NO WAY intended to be a realistic analysis of expectations of things to come. Invest, don't gamble. I'm in it for the long term. Don't take anything in this post as anything remotely resembling financial advice, recommendations, or analysis.

Hovnanian update

I just found this little write-up:

http://www.cnbc.com/id/20810847

Two things:

1. Apparently, the sale went well, at least in some regions. Like I said in the analysis, I think that will be good, at least in the short term.

2. Also, they said that they would release official sales figures Tuesday. Coupled with the Fed meeting, Tuesday will probably be a make-or-break day for Hovnanian, depending on the news.

It's going to be a wild week... like I said before, I like the long term prospects of the company; the short term is too unpredictable and risky.

Individual Stock Analysis: Hovnanian (HOV)

The housing bubble has been one of the most talked-about topics over the past year. Due to low interest rates and lots of individual and corporate speculation, housing prices artificially blossomed right after the turn of the millennium.

As a homebuilder, Hovnanian (HOV) benefited from this trend. I have a chart below in the article, and take a look at it; the "stock price" is my approximate average yearly price based on real monthly close price over the past 10 years. As you can see, Hovnanian's stock enjoyed an incredible increase in the years up until July of 2005, when it had a monthly close of $70. The stock was trading in the $3-5/share range in the late 1990s, and if you had timed the low precisely, you could have purchased shares for $2.75 each in May 2000, scoring yourself a 25-bagger if you had timed the low and high precisely.

(That's unrealistic, and not the point of this article. But in doing the research for this analysis, those were some interesting statistics I sorted through).

Fundamentally, Hovnanian is very cheap right now. I can't do this analysis based on P/E, because Hovnanian is currently losing money (as homebuilders regularly do during the negative parts of the housing cycles). Plus, according to lots of professional, successful analysts, price to book value is a much better indicator of true company worth.

Below is a chart plotting my approximate average yearly share price versus a mathmatical function of the yearly price/book value ratio. (Price data was obtained at finance.yahoo.com, while price/book ratios were found at Morningstar.com.)

The formula that I used to create a chart that exemplified my point was:

((Book Value x 4)/1.6)^2. The formula allowed the data to be comparable on the same graph. If you'd like a further explanation, click here to download a short explanation in microsoft-word format.

My point is, the share price of Hovnanian has closely followed its book valuation over its history. However, today represents its lowest price/book ratio in the 10-year statistical history, by far. Here is the history, in one-year intervals:

Year	1997	1998	1999	2000	2001
Price/Book	0.9	0.9	0.6	0.8	1.6
2002	2003	2004	2005	2006	TTM
1.7	3.2	2.5	1.7	1.2	0.4

Youcan see that the price/book value is inflated in a great (overvalued/bubble) housing market, while depressed in a tough housing market. However, even during the bottom of the previous housing cycle in the late 1990's, the lowest price/book ratio Hovnanian had was 0.6. Today, that ratio is 0.4. That number is one-third lower than the previous low, which is statistically significant; if the stock was trading at a 0.6 book value today, it would be over $16/share.

So, strictly on valuation, I think that Hovnanian is currently looking fundamentally cheap. However, I think that there are other reasons why Hovnanian is attractive right now. The company does business in at least 19 states, with multiple markets within most states. They create housing developments, but also will build one of their housing plans on an individually-owned lot. This diversified business model will, I believe, help to cushion the effect of this housing bust. Yes, Hovnanian is exposed in some of the worst markets, like Florida and California, where housing is expensive and speculation was rampant. However, it also has operations in communities right around me in Western Pennsylvania, where housing prices are steady, or even increasing.

Hovnanian has already cut many of its losses, writing down land and options in some of the most expensive, volatile markets. I'm not going to naively predict a full housing recovery in the near term, but I believe that Hovnanian has already accounted for many of its liabilities.

Plus, two short-term events could positively affect Hovnanian's business.

First, the "Sale of the Century," a three-day event this past weekend that included price slashes of up to 20% on Hovnanian homes, could generate lots of cash, allowing the company to keep operating normally while removing some of its financial obligations. Though a deeply-discounted home will obviously not yield as much as a full-price home, right now I think it's important for Hovnanian to unload lots of the homes and land that they currently have to pay to maintain. An important feature of the sale is that many of the less-expensive properties will now fall below the price cutoff of a jumbo-mortgage, allowing buyers access to more affordable rates, especially because the lending market has tightened.

Second, the result of the Federal Reserve meeting on Tuesday will surely affect Hovnanian. Surely, a cut will be beneficial, allowing freer access to capital for all. I think that the general market reaction is going to be more unpredictable; it currently seems like either a 25- or 50-basis point cut can be the right or wrong decision. However, I think that the news of any cut, which should occur, will at least be a symbolic gesture that will help restore some confidence.

I have no idea when the bottom of the housing market, and stocks like Hovnanian, will occur. Personally, I initiated a long position in Hovnanian around $15/share, when I thought it was cheap; it's 52-week high is around $40. However, I have no idea if $10 a few days ago was HOV's bottom (that's the least likely scenario), or if it may fall back to $10, or $8, or even less in the coming months or years. However, I think that Hovnanian has the fundamentals to survive this bust; even if it becomes more troubled than it is, I can see a large bank or investor not allowing the company to go out of business.

Hovnanian was probably overvalued at $70 when the housing market was at its over-inflated peak, but I don't think it's a $10 stock either. Based on a rough average price/book valuation of 1.5, that translates to a stock that would be $40 based on today's book value. Even if that estimate is high, it's clear that Hovnanian is clearly NOT a $10 stock.

I don't give financial advice, but if I did, I would not recommend getting into this stock tomorrow morning in anticipation of good news concerning the sale and the Fed. Those are two short-term good-news injections that may temporarily raise the stock price. However, I think the big picture is more important; Hovnanian is trading at a historic low, both in terms of actual price AND valuation, and as the housing market recovers, in 1, 2, or 5 years, Hovnanian's share price should mirror the change.

Disclosure: Author is long HOV.

Weekly Wrapup: September 10-14

It was a great week for the market; the major indexes all enjoyed gains of at least one percent. Here are weekly charts, courtesy of Marketwatch.com:

Dow Chart 9/10-9/14

NASDAQ Chart 9/10-9/14

S&P 500 9/14-9/14

As the charts show, each index posted gains for the week... and if measured from the bottom of the lows on Monday, the weekly increases are even more impressive.

Moving on:

A few interesting things happened with the stocks I own or watch this week. Syntax-Brillian (BRLC), which I had a small speculative position in, first delayed earnings, then disappointed the street by revising its future outlook downward. It fell from almost $7 on Monday to $4 this Friday.

Obviously, the company should be a little cheaper, because it did revise its future estimates. However, I do not believe that this stock deserved the downfall, or will trade at this price forever. Along with the quarterly results, BRLC reported yearlong earnings of $.48/share. At the current share price, BRLC is an 8 P/E stock, which is utterly unheard-of for such a small, high-growth company. Revenue and income continues to grow quickly (just not as quickly as expected), with demand out pacing the company's ability to supply.

I doubled my tiny position around $4 a share, and I believe that this stock will trade much higher than it does today. Unless there is some massive scandal or other major unforeseen problem, based on the current numbers and market conditions, I feel as though BRLC is beaten-up and undervalued in the long term. I don't know if it's going to "pop" anytime in the near-term, but in a year, I would not be surprised if it was at $8 or $10 per share.

Another interesting happening:
I purchased a tiny position (500 shares at $.56) of an even smaller TV maker, Soyo (SOYO.OB). Other than some news about a very small stock purchase by the CEO, information about sponsorship of a fighting candidate, and a reiteration of earnings guidence (of 7+ cents/share for the year), there wasn't much news; however, the stock shot up to $.92 on Friday, before closing in the 70-cent range.

Generally, I don't invest in "penny" stocks because it's unpredictable and more like gambling than investing. However, whenever I discovered Soyo, I researched it and really liked the company - it started as a company making specialty motherboards for gaming computers, and eventually got into the LCD TV market. Now, they produce a 24" TV that has 50% market share at that size, and signed a long-term contract to distribute products under the widely-respected Honeywell brand name, starting with portable USB drives this year and including big-screen HD LCD TVs next year. I like this little company in the long run; I could care less about the daily volatility and short term gains, becuase if this work out well, this company could be worth much more in the long run.

Along with the rest of the market, most of my other positions were up, including Marathon Oil (MRO), Electronic Arts (ERTS), and Sun Microsystems (JAVA).


For the upcoming week, markets will be focused on the Fed meeting on Tuesday. The decisions concerning interest rates will surely set the tone for the week. One of my positions, Hovnanian (HOV), will definitely be effected; I'm going to have a full-article writeup about it posted later tonight or tomorrow.



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Wild Day, Mild Finish

Following Friday's fiasco, today's trading began unpredictably. Futures began positive, then leveled off. During the course of the day, the markets swung up and down: the Dow traded in a range of 150 points, ending the day up marginally, while the Nasdaq was down almost 1% at one point, and ended with a loss of one-quarter percent. The S%P 500 recovered from a 1% deficit to close almost unchanged.

There were some movers today:

• Apple (AAPL) announced that it had sold its 1 millionth iPhone, and recovered $5 (3%) of last week's losses. The announcement verified that the iPhone is selling very well; Apple's own goal was to sell one million units by the end of September. The news today seemed to calm investor's nerves, after the unsettling price cut on the device last week.
• Countrywide (CFC) fell 5% today after announcing Friday that it was terminating another 12,000 jobs.
• Homebuilders declined, with all major companies falling by over 2%. My Hovnanian (HOV) led the way, giving up another 5% to close at a multi-year low. Hopefully, if the Fed decides to cut rates, the homebuilders will be the first to react positively.
  
• Harley-Davidson (HOG) fell an additional 3.5% today after declining almost 10% on Friday. A bleaker earnings forecast caused the decline; however, I feel as though the stock price may be over-reacting.
  

That's all for now; hopefully I'll have a chance to write another individual stock analysis later tonight or tomorrow.

Pre-Market Report

What will trading on Monday, September 10th be like? It's not certain, but lots of indicators are pointing to another day of selling. Asian markets were down during their sessions, and the market could likely keep reacting to the unfortunate economic news from Friday. Plus, there is now speculation that the Fed may not cut rates during its meeting this month, because of fears of uncontrollable inflation.

I think it's going to be a wild day. But, who knows, the indexes might end up flat for the day. Some stocks I'm personally going to be watching:


Apple (AAPL), still reeling from the negative opinions stemming from its price cuts and new product line, has lost almost 10% of its share value over the last few days of trading. I think it will continue slipping today, but it also might hit a bottom.

Countrywide (CFC) announced on Friday that it will be cutting approximately another 12,000 jobs.

Homebuilders (in particular, I own Hovnanian (HOV). As a sector, they posted major losses on friday, mostly because of the weak economic data. A rate cut could really help homebuilders, so if speculation is positive (or an early rate cut occurs) they could move significantly.



That's all for now; check back later for daily post-close wrapups every day, plus insight into the market and individual companies. Subscribe to my blog, or just bookmark it!