Toll Brothers (TOL) announced fiscal second quarter financial results this morning. Investors welcomed the news and bid the stock higher. Revenues were up 16.7%, which was in line with expectations. Per share earnings, however, beat the $1.03 consenus estimate by three cents.
But don't be fooled by these seemingly good results. While EPS increased 6% year-over-year, net income climbed only 2.8%. You see, TOL beat the per share estimate because the weighted average number of diluted shares outstanding is 3.6 million fewer than it was a year ago. In fact, TOL repurchased 1.3 million shares in the fiscal second quarter alone, paying an average price of $30.49 for each share. Despite today's rally, the stock is selling below this level. This raises the question, why did management buy back shares? Did they believe the stock was cheap? Or were they trying to reduce the share count to increase the likelihood of beating the earnings estimate?
To management's credit, it provides a lot of metrics on the business. But whether you look at units sold, contracts signed, or backlog, they all point to slowing growth. In fact, including unconsolidated entities, contracts fell 31% from the fiscal second quarter of 2005. The company also lowered earnings guidance for fiscal 2006, at least in part, because of higher material and labor costs.
Many analysts point to the low multiples in this industry and say these homebuilders are very cheap. They're right. TOL is selling for less than six times fiscal 2006 expected earnings. However, the problem is that future earnings estimates are lower than actual earnings in recent periods. The valuation multiples are low for a good reason. Investors have come to believe that growth has ended.
With inventories rising and housing prices likely to come down--or at best, remain flat--this doesn't seem like the best time to jump into homebuilding stocks.
