There’s little question that homebuilders are one of the most hated industries out there. That’s no surprise… Following the very public real estate bubble of 2008, homebuilders found themselves struggling to meet stringent debt payments, selling off inventory at bargain prices, and burning cash like kindling. And through 2010, the situation hasn’t much changed. But that’s exactly why one homebuilding stock looks like a potential buy right now.

I’m no fan of homebuilding stocks in general. While homebuilders have been punished financially, few would argue that they didn’t deserve it – by operating highly leveraged businesses in what amounted to an incredibly speculative real estate bubble, these firms bet millions on the hopes that they’d continue to sell new construction at a breakneck pace.

And for a while, they did, picking up droves of excited investors who saw generous dividend yields and substantial growth.

One of the biggest beneficiaries of that excitement was Beazer Homes (NYSE: BZH), a Georgia-based small-cap company that counts itself as one of the nation’s ten biggest homebuilders. Between the beginning of 2000 and the end of 2005, shares of this firm rocketed more than 1,200% on hopes that residential construction would continue to grow.

What made Beazer more attractive than some of its peers was the fact that the company wasn’t just the builder – the company also developed the communities it built and helped finance its homebuyers. That meant significantly higher profits than a general contractor alone would see… but it also exposed the firm’s balance sheet to substantially more risk.

That risk came to bare in 2007, when the company lost 84.8% of its value amid the mortgage meltdown. It continued in 2008 when Beazer shareholders saw their investment fall another 81.5%. And while the stock has rebounded somewhat since, it still trades at around a 96% discount to its 2006 valuation.

Things were made worse through scores of mortgage origination and accounting violations that culminated in the firing of Beazer’s Chief Accounting Officer in 2007 for allegedly shredding financial documents – and resulted in financial restatements with the SEC and punitive damages of $53 million.

So, why would anyone want to touch this stock?

Now that the skeletons have been shaken out of Beazer Homes’ closet – and forensic accountants and auditors have pored over the company’s books with a fine-toothed comb – nearly all of the company’s business risks have been disclosed and priced into shares. And although there are still significant doubts about the short-term future of the real estate market, massive write offs in 2007, 2008, and 2009 have given the books a conservative bent.

To be sure, Beazer deserves to trade for significantly less than its 2005 high – but it looks like it should be priced at much higher than its current bid. A cursory analysis under relatively modest growth assumptions puts the company’s valuation at $5.09 per share, a 48% upside.

But while this play is compelling on many fronts, I would only recommend it to the most speculative of investors. Beazer still faces considerable challenges in a less than favorable economic climate – and with home starts and unemployment numbers far from recovered, the firm will be treading water for some time, and the risks are too high for many readers.

Stay tuned next week for some less speculative small-cap investment ideas…

Sincerely,
Jonas Elmerraji
Managing Editor, Penny Sleuth

[Independence Note: As with every company we mention here in the Penny Sleuth, neither the author nor any of the Sleuth’s other editorial staff have a financial position in Beazer Homes. Because of that, we’re completely independent, and able to provide you with unbiased analysis – try holding other penny stock newsletters up to that same standard. ]

July 9, 2010

Jonas Elmerraji

A big-four public accounting alum, Jonas Elmerraji brings his readers extensive expertise in small-cap stocks and broad market moves. Elmerraji’s interest in the market started with an investing course in elementary school – today he holds a degree in financial economics from UMBC and specializes in blending fundamental and technical analysis. Elmerraji has contributed to Forbes, TheStreet.com, and Investors Business Daily among others. He is managing editor of the Penny Momentum Trader, and a co-editor of Penny Stock Fortunes.

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