Homebuilders are missing out on the secret sauce fueling the stock market
Profit margins are expanding for the S&P 500, but not for homebuilders.
One of the best arguments for why US companies can sustain lofty valuations is high profit margins.
Simply, the companies that populate the S&P 500 are better than ever at efficiently turning sales into profits. Margin expansion is the US stock market’s secret sauce. And while most companies — in particular, mega-cap tech stocks — have it, homebuilders are one pocket of the market that doesn’t.
Case in point: Toll Brothers, which fell about 5% at the open on Tuesday after reporting quarterly results after the close on Monday.
Toll said its first-quarter adjusted home-sales gross margin would be 26.3%, a full percentage point below Wall Street’s estimate.
High interest rates continue to wreak havoc on the US housing market. Even the luxury homebuilder — whose customers are better positioned to grapple with high borrowing costs — has had to buy down mortgage rates to entice would-be buyers, along with other incentive programs.
That’s not a company-specific problem, but rather a broad industry issue: as the S&P 500’s expected profit margin in 12 months’ time has continued to climb, the Dow Jones US Select Home Builders Index has seen its presumptive profitability roll over.
During a conference call, Toll’s management said that the low margin in Q1 was “a bit of an anomaly from both a mix and incentives perspective.”
It’s clearly an issue that’s front of mind for the C-suite.
“We want to reiterate our focus on returns and what we’ve been able to accomplish with return on equity through the combination of elevated gross margins, high gross margins, good operating margin, and capital redeployment through dividends and repurchase,” Martin Connor, Toll’s chief financial officer, said.
