Skeptics In Pulte Homes Next Bull Run May Get Burnt

Key Points

• PulteGroup stock has been rising during Tuesday's trading session. This reaction comes after markets properly digest the second-quarter earnings results released by the company.
• Peer group stock performance may be an initial viewpoint of where markets believe the stock's potential lies; however, these valuation metrics may be a disconnect to this favoritism, increasing the potential upside in the company.
• Breaking down the business model's fundamental drivers, investors realize that a new all-time high price may be in the works.

The residential construction sector has seen a stratospheric rise during the past year and a half, with leading dynamics in the underlying economy fueling further demand for housing and further amplifying the need for construction. PulteGroup NYSE: PHM is one of the lucky names that rode the rally wave with still more upside potential than meets the eye.

These industry-wide tailwinds support a recent all-time high in the stock; however, the push for new highs - or the rejection of a significant pullback - may be built after markets properly digest the results published for the second quarter of 2023. Pulte stock is up by as much as 4.8% during the morning hours of Tuesday's trading session, an initial reaction to what is in store for the future.

Analysts may point to the more conservative end of the spectrum regarding consensus price targets, as it will become evident when comparing Pulte to other names in the sector. Today's earnings results may carry subtle hints from insiders, who are also hopping on the train for the next potential rally.

Where the Potential Lies 

Looking at other well-known names in the residential construction industry, such as D.R. Horton NYSE: DHI and NVR NYSE: NVR, can lead investors down the right rabbit hole. Immediately, there will appear an apparent disconnect between price action and current valuation metrics will appear, which may open up the path for Pulte to keep pushing for new highs.

Pulte stock has outperformed these other competitors in the space by as much as 48% during the past twelve months. This is obviously the first sign of favoritism in the stock market machine, which is known to fall into the habit of rewarding stocks that become popular.

Despite this performance gap during the period, valuation metrics will point to Pulte as the one stock that still carries the most upside potential, regardless of what analyst targets may imply. Pulte analyst ratings suggest the stock is pregnant with downside risk, indicating an 11.1% implied decline from today's prices.

Analysts may be looking to hedge their views, as placing a high potential upside on a stock with such a massive run can put their necks on the line. Going against the trend can often pay handsome rewards, but not today. Going against the enormous momentum seen in the company can be the root of the pain.

Spreading out valuation metrics across the sector, especially the forward price-to-earnings ratio, can provide a pillar of strength for investors to lean against. The forward P/E gives a deeper insight than the traditional P/E in that it gauges where markets value the future potential of a respective stock.

Pulte Homes trade at an inferior forward P/E of 8.4x, whereas competitors (who underperformed price action-wise) like D.R. Horton and NVR work at significantly higher ratios of 10.0x and 15.5x, respectively. This opens up the way for Pulte's business model and financial momentum to close the valuation gap against the peer averages.

The next step in investor due diligence is to hover around the company's earnings release, focusing on identifying the drivers behind earnings growth and the drivers behind the setup for a new rally in the stock. Far from an incentive to fight against analyst consensus, these drivers should act as a compass for investors to time a potential purchase better.

Earnings, a Window to the Future

Home sales revenue grew by 8% during the past twelve months, and that should be enough for management to 'drop the mic' and walk away. During a year when the United States FED raised interest rates and pushed demand for housing lower due to more expensive mortgages, posting an above-inflation revenue growth rate became all the more impressive.

The past is less important than the future for the business model, so investors can hover to the next best thing in the report. Net new orders reported a 24% annual increase, for a total value of $4.3 billion, acting as a future accrual to net sales when these projects hit the market.

Now, where did management gain the confidence to repurchase as much as $250 million of stock during the quarter? Perhaps insiders felt comfortable staring at a total unit backlog of 13,558 homes, implying a total current value of $8.2 billion. Since cancellation rates are declining faster, these backlogs and orders are becoming more confident than ever.

Increasing certainty in the company's future financial growth and share buybacks may be the last straw for those in doubt about where the next rally in the stock may be coming from. As management is screaming that they believe the stock to be cheap, valuation gaps may be no more.