How to play a homebuilding rebound

For the first time since the 2008 housing collapse, we see signs of hope and an investment opportunity in the sector.

Consumer sentiment is improving. And affordability against median income is at one of its lowest points in history. All this has begun to move the markets. Here's a look at a variety of favorite stocks and ETFs to play this trend.

Some cautionary thoughts come to mind before I get to my recommendations. First, I believe the overall market is due for a fairly significant pullback. Second, the homebuilding stocks -- up about 85% since last October -- may pull back even more given the recent run they've had.

Once this happens, then I think you can begin to build positions. If you just can't wait or if I'm wrong you can take small positions now but no more than about 25% of your final target position. But over the longer term, 24 months or so, stocks in this area will continue to improve.

I am recommending SPDR Homebuilders ETF (XHB). This is an interesting basket of not only the major home builders like Lennar (LEN), D.R. Horton (DHI), and PulteGroup (PHM).

It also holds a selection of related companies such as Home Depot (HD), Whirlpool Corp. (WHR), TempurPedic International (TPX), and Pier 1 Imports (PIR).
The units are up just over 14% over the past year compared to 5.5% for the S&P 500. Total holdings include 27 firms with roughly 30% of its assets in homebuilders and the rest in manufacturers and providers of home furnishings.

Another one that is worth a look is the iShares Dow Jones Home Construction ETF (ITB). Two-thirds of the total holdings of this fund are homebuilders.

Firms in the building materials segment occupy nearly 20% of the portfolio and home improvement related companies pick up another 9% of the total assets.

Names like Sherwin-Williams (SHW), Masco (MAS), and Ryland Group (RYL) are included in this basket. D.R. Horton (DHI) and NVR Inc. (NVR) are the two largest holdings.

This issue has not done as well as XHB, gaining 7.9% this past year compared to 5.5% for the S&P 500. Historically the two issues trade similarly, but overall performance has been better with XHB.

Of course you can research individual stocks in these groups and look for higher Beta (more risk, higher return potential) than you will get from the ETFs.

Toll Brothers (TOL) is one of my favorites but, as usual, you will trade some peace of mind for the possibility of improved performance.

For a lower-risk way to play PulteGroup (PHM) is another favorite; this is an unusual stock in that it is based on a 40-year debt instrument. As such, there is very little upside price potential here.

However, it pays a hefty dividend, unlike the common shares which had their dividends suspended after the housing market collapsed. The current payment is $1.84 per share annually for an attractive yield of 7.4%.

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