Interactive Investor

Does Warren Buffett’s sell order signal end of this sector rally?

America’s most famous investor has made a big profit on this trade, but he’s just bailed out. Is this a bad sign for the sector? Overseas investing expert Rodney Hobson gives his view.

6th March 2024 08:45

Rodney Hobson from interactive investor

Whatever Donald Trump and his supporters may claim, President Biden has not trashed the American economy. While it is not for this column to take political sides, it is obviously essential for investors to have a grip on economic reality, and the reality is that the United States has come out of the pandemic in better shape than the UK or Europe, with clear implications for the housing market there.

This is a very different situation to 2008, when US housing was at the sharp end of the financial crash and repossessions were the norm, leaving swathes of the country depressed. Although rising interest rates have had an inevitable impact on those with or taking out mortgages, the US labour market remains strong, leaving many families with sufficient income to ride out the difficult times.

Housing starts rose 7.6% year-on-year in December. Pending home sales and building permits issued were both well up on November, so the improving trend is set to continue for now.

However, there is no getting away from the fact that higher interest rates are here to stay after a decade of ultra-low rates, and the Federal Reserve Board is unlikely to rush to start to reduce the current level in an election year. The Fed has a reputation for tardiness in moving rates up or down. It was slow to react to heightened inflation and it is likely to be reluctant to start cutting before its members are satisfied that interest rate reductions are sustainable.

In any case, interest rate changes are slow to feed through into the economy and any borrowers on low fixed rates will be forced to remortgage at higher rates for the foreseeable future, while newcomers will pay more from the start.

In addition, home sales slumped during the pandemic, so part of the rebound is due to two years’ worth of pent-up demand. Yet shares in the sector have continued to power ahead.

Ashtead Group (LSE:AHT), the UK plant hire company with most of its business in North America, sounded an ominous note this week with results showing higher revenue but lower profits, not what investors want.

D.R. Horton Inc (NYSE:DHI) is the largest housebuilder in the US. Its most recent results, published in January, showed revenue in line with expectations at $7.7 billion in the first quarter of its financial year but earnings per share (EPS) were disappointing at $2.82.

Analysts could be disappointed again as 2024 progresses. They hope that revenue will increase by about 4% in the current quarter to easily top $8 billion. While that is certainly achievable, their hopes of a double-digit improvement in EPS to above $3 looks rather more problematic.

Horton shares have quadrupled over the past four years to top $150. The price/earnings (PE) ratio is still only 11 but the dividend is a measly 0.7%.

Source: interactive investor. Past performance is not a guide to future performance.

KB Home (NYSE:KBH) has also hit a new high at $68, where the shares are slightly more attractive than Horton’s with a PE just under 10 and a yield marginally better at 1.11%. Its earnings are expected to grow at 7.8% but, as with Horton, that could well be scaled back as higher interest rates bite.

Source: interactive investor. Past performance is not a guide to future performance.

Hobson’s choice: Along with other housebuilders, I tipped Horton at $71.50 nearly two years ago after an overdone correction, but later turned less enthusiastic. Berkshire Hathaway Inc Class B (NYSE:BRK.B), the vehicle of fabled investor Warren Buffett, has just sold its entire stake in Horton. I think another correction is well overdue. Follow his lead and sell. I prefer KB Home, though cannot rate the shares better than a ‘hold’ at this stage.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.

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