KB Home (KBH) is going to blow past earnings tomorrow and boost the entire housing sector. XHB, Lennar (LEN) and D.R. Horton (DHI) will all be positively impacted by an earning beat by KB Home. Below I have provided a couple pieces of data and charts to get you warmed up for my larger argument below. Notice that one year ago analysts thought KB Home's earnings this quarter would be -1.49 per share. Now they think it will be -0.24. That is a large change in a year. Also look at the difference in open interest between the calls and the puts for APR 2012.
Current Price: 11.06
Today's change: $ -0.25
Open Interest Calls (12-16): 52,849
Open Interest Puts (11-7): 29,924
From Yahoo Finance:
| Earnings Est | Current Qtr. Feb 12 | Next Qtr. May 12 | Current Year Nov 12 | Next Year Nov 13 |
|---|---|---|---|---|
| Avg. Estimate | -0.24 | -0.19 | -0.34 | 0.41 |
| No. of Analysts | 22.00 | 21.00 | 25.00 | 18.00 |
| Low Estimate | -0.37 | -0.32 | -0.90 | -0.75 |
| High Estimate | -0.06 | -0.08 | 0.48 | 1.44 |
| Year Ago EPS | -1.49 | -0.89 | -2.32 | -0.34 |
|
| Growth Est | KBH | Industry | Sector | S&P 500 |
|---|---|---|---|---|
| Current Qtr. | 83.90% | N/A | 87.90% | 17.00% |
| Next Qtr. | 78.70% | 166.10% | 84.90% | 15.30% |
| This Year | 85.30% | 122.10% | 75.40% | 11.10% |
| Next Year | 220.60% | 54.90% | 14.60% | 13.50% |
| Past 5 Years (per annum) | 1.00% | N/A | N/A | N/A |
| Next 5 Years (per annum) | 7.67% | 11.31% | 18.77% | 10.51% |
| Price/Earnings (avg. for comparison categories) | -33.97 | -17.50 | 10.12 | 15.10 |
| PEG Ratio (avg. for comparison categories) | -4.43 | -1.40 | 2.37 | 4.41 |
KB Homes is a leader in new residential construction. Since most of its competitors got wiped out by the credit crisis, KBH is well positioned to grab market share. Since KB Home is a leader in new residential construction, the economic indicator of "new housing permits" is critical to the company's performance. Without a permit new homes cannot be made. So, an increase of permits means an increase of people trying to buy homes. It's as simple as that.
Using census reports we can directly compare KB Home's quarterly performance to the amount of new housing permits generated during that time. The results are as follows:
Current Quarter: (Dec 2011, Jan, Feb, 2012) New Housing Permits: 2,070
Net Income: 13,911
Gross Revenues:479,872
Last Quarter: (Sept, Oct, Nov, 2011) New Housing Permits: 1,913
Net Income: (9,649)
Gross Revenues: 367,316
Two Quarters Ago: (Jun, July, Aug, 2011) New Housing Permits: 1,843
Net Income: (68,504)
Gross Revenues: 271,738
Three Quarters Ago: (May, Apr, Mar, 2011) New Housing Permits: 1,746
Net Income: (114,526)
Gross Revenues: 196,940
As the quants say, there seems to be "chi by eye" between new housing permits and the performance of KB Home. Do not get sandbagged by the negative performance of the stock today. It is likely that clearing houses are dropping the stock to protect positions for the coming rally tomorrow. These institutions have access to information faster than anyone, and are in the business to make money. Higher volatility means higher spreads, and higher spreads means a lot more money for the trading houses.
The options trade:
APR 2012 Call Spread @ 11/12 (Spread 1)
Break-even: 11.42
Max Loss: $42
Max Profit: $58
Return on Risk: 138.1%
APR 2012 Call Spread @ 12/13 (Spread 2)
Break-even: 12.24
Max Loss: $24
Max Profit: $76
Return on Risk: 316.67%
I suggest a 2:1 ratio between Spread 1 and Spread 2. With this trade you can limit your risk, (2:1 Total Risk: $108) while still retaining the ability to capture a large move in the stock price.
Disclosure: I am long KBH.
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