Bet now on the real-estate rebound

By Harry Domash

Editor's note: To view the stock screens mentioned in this column, download the free MSN Money Investment Toolbox.

Most home builders' share prices have dropped 50% or more over the past year. But these money-pit stocks could be ready for a comeback.

That's not to say the bad news about the companies will get better right away. In September, existing-home sales dropped for the sixth straight month, and the median sales price fell by the largest amount on record. September new-home sales climbed, but only because builders slashed prices. Indeed, the median price for a new home plunged 9.7% from September 2006.

Inspired by these reports, pundits are telling us that the housing market will continue its death plunge well into next year. But will it? Consider this.

Employment is still strong and plenty of folks who have the desire and the means to buy aren't doing it. Why? For most of us, buying a home is the biggest investment we'll ever make. Would you buy a house when everyone is telling you that home prices are headed down? Me neither. But the demand isn't going away. The ready and willing buyers are waiting for a signal that home prices have stabilized. Everybody wants a bargain, and many will rush to buy if they think that prices are headed back up. That signal could come early next year.

As you probably know, the real-estate credit market froze up in August. Mortgage makers were closing their doors in droves, and many buyers sat on the sidelines waiting for the mortgage market to settle down.

When a home sells, it usually takes one to two months from when an offer is accepted until escrow closes and the sale is reported in the sales figures. So the lackluster September sales figures reported last week reflect what happened in August. Because many deals take two months to close, October numbers won't be much better. Then come the holiday months, which are always slow for real estate.

But come January, with mortgages readily available to qualified buyers, sales will likely pick up. If you agree with that scenario, this is the time to take a serious look at home builders' stocks. Don't wait for January. The market moves in advance of actual news.

I built a simple screen to ferret out the stocks likely to do the best when the market recovers. Out of 25 home builders, only four stocks passed the tests. Then, after I checked an additional risk factor that can't be done by screening, only two stocks survived. Here are the details, starting with the screen.

Industry

Since the MSN Deluxe Screener has a separate industry category for home builders, I started by limiting my search to the 25 stocks in that category.

Screening parameter: Industry name = residential construction

Low debt

With rampant price-cutting and sales levels at multiyear lows, many home builders are reporting losses. Given that situation, plus the chaotic credit markets, the last thing we need is home builders burdened by high debt.

Unfortunately, almost all builders borrow to finance land purchases and construction costs. So, rather than set an arbitrary limit that most builders would flunk, I require only that passing candidates carry debt at or below the industry average.

To measure debt, I use the debt-to-equity ratio, which compares total debt to shareholders' equity (book value). Zero ratios reflect no debt -- and the higher the ratio, the higher the debt.

Screening parameter: Debt-to-equity level <= industry average debt-to-equity level

Adding that stipulation reduced my list of home-building candidates to seven stocks. The average ratio for the home-building industry was 0.72. If you want to see more candidates, try searching for stocks with debt-to-equity ratios below 1.0 instead of comparing with the industry average.

Continued: Finding the most profitable players

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