High Beta Small-Cap Investing in the Housing Market; Risk Could Translate into Reward

High Beta Small-Cap Investing in the Housing Market; Risk Could Translate into Reward

On Tuesday of last week, U.S. home builder sentiment slipped to 46 after hitting a seven year high of 47 in January. Anything over 50 indicates that builders see conditions as good rather than poor. The National Association of Home Builders’ monthly confidence index shows that this is the first weakening in 11 months and levels now stand at four points from the line between positive and negative sentiment. Still, the index, which mirrors the volume of new housing starts, is at least 18 points higher than it was one year ago and at its peak level since May of 2006.The lackluster report comes on the heels of a surge in homebuilder stocks for most of 2012. On average, shares rose 122.8 percent in 2012, compared with the S&P 500’s 13.4 percent rise.

So, why did the numbers slip this month? The slight trend downward is partly attributed to uncertainties about still high unemployment and consumer access to mortgage credit. It also is a reflection of builders that are dealing with rising costs of building materials and limited availability of skilled labor in some markets as the demand for new homes strengthens. Home owners that were facing the possibility of the economy tanking with the fiscal cliff are now dealing the possibility of sequestration, which could involve thousands of job cuts and cause both home buying and remodeling to reverse course further. Potential first time buyers are being squeezed out by rising mortgage rates and tight credit. In addition, falling inventories are making it more difficult for current homeowners to move up. And finally, the housing market appears to be in the hands of all-cash investors who are looking for distressed properties to flip and then rent out. In the end, at least for now, this distressed housing market may be what keeps home sales afloat.

If an investor wants to be long in the housing market right now, the higher beta names are the way to go. Beta is a measure of a stock’s volatility in relation to the market. The market has a beta of 1.0, and stocks are ranked according to how much they diverge from that number. A stock that moves more than the market has a beta above 1.0. A stock that moves less than the market has a beta that is under 1.0. A high beta stock is apt to be riskier, but with risk comes the potential for higher returns. On the flip side, low-beta stocks equal less risk and lower returns. So look for small-cap companies that are a little further out on the risk curve. They have the potential for price growth and low 30-year fixed mortgage rates that translate into a ton of purchasing power for consumers. Companies such as Meritage Homes Corporation (NYSE: MTH), Hovnanian Enterprises, Inc. (NYSE: HOV) and Beazer Homes USA, Inc. (NYSE: BSH) are all good bets now. HOV currently has a beta of 2.67, MTH has a beta of 1.46 and BSH carries a 3.39 beta.

The bottom line is that housing is still rebounding, even with the slight dip in numbers this month. Things are getting better and one dip does not a crash make. There is still a lot of room for sentiment to run. If you are considering investing, look for higher beta small-caps with growth potential for the long-term that could yield higher returns.