Saturday, May 20, 2006

For Whom the Bell Tolls

This is a big week for the housing sector. On Tuesday, homebuilder Toll Brothers (TOL) announces its fiscal first quarter financial results. The betting is for revenues of $1.45 billion and per share earnings of $1.03. To put that in perspective, revenues for the same quarter a year ago were $1.24 billion. At that time, TOL earned $1.00 per share.

So analysts are calling for 17% revenue growth, but only 3% growth for per share earnings. Why the big difference? Because TOL, like many homebuilders, is offering incentives to keep houses moving. As a result, profit margins are shrinking even though quoted prices are holding up. Despite all the incentives, however, homebuilders are still making lots of money. Nonetheless, the stocks are way off their highs because investors smell slower growth ahead. In fact, TOL is already down about 50% from the highs it hit last July. Other homebuilders have suffered similar selloffs.

What TOL says about its first quarter results, however, is not as important as what it might say about the outlook. If management gives any indication that growth is slowing more than expected--or worse, that growth has come to an end--we'll see further selling in the entire sector. Let's just hope that TOL doesn't pull a fast one and refuse to provide any guidance. Many companies have done that once they entered a period of slowing growth.

The excitement in the housing sector will continue on Wednesday when the new home sales figures come out. The expectation is for 1.15 million. Existing home sales figures come out on Thursday. The consensus estimate is for about 6.8 million. There already is plenty of evidence that the housing boom has ended. However, if actual results fall significantly below current expectations, the selling in this sector could get really ugly.