WITH THE SPRING

home-buying season off to a weak start, it's clear many house hunters still aren't ready to call a bottom in the real-estate market. But what about investors?

The stocks of several major home builders are breathing new life lately. Shares of Toll Brothers, Lennar, Pulte Homes, Hovnanian Enterprises and D.R. Horton are all up since January. At the same time, they're well below their peak prices. For bargain hunters, it's tempting to see good deals in this depressed yet seemingly recovering sector.

But retail investors should tread cautiously. Home builders themselves have refrained from letting out any celebratory sighs of relief. The National Association of Home Builders just this month said its sentiment index is close to a historical low, and "the housing market has shown no evidence of improvement thus far." If your time horizon is the next year or so, you might as well flip a coin. For investors looking out three years or more, the big builders are relatively safe bets if they've weathered past downturns and have strong balance sheets that can withstand more losses.

"If you define risk as volatility then housing stocks are still risky," says Josh Spencer, a research analyst at T. Rowe Price. "If you define risk in terms of long-term value they're not so risky. They're cheap enough to be good stocks if the housing market gets better years from now, but they're not profitable today."

Spencer says Toll Brothers and Pulte stand out, with Toll Brothers the stronger of the two. "You can't go wrong with Toll Brothers. They've built up cash so they're well positioned to put that to work and buy cheap land," Spencer says.

Toll Brothers, which builds higher-end homes for non-first-time home buyers, finished its April quarter with $1.23 billion in cash. On a conference call with investors, the company said its spring selling season was weak in most markets. But Chief Executive Robert Toll, who has headed Toll Brothers since its founding in 1967, also said there are signs of "significant pent-up demand." Soleil Securities analyst Anna Torma, who recently raised her price target on Toll Brothers' stock to $28 from $24, said in a research note on May 16 that Toll's business could stabilize by year's end. "The company has responded effectively to the downturn and is well positioned for the eventual recovery," Torma said in the note. She also said Toll has "a very conservative balance sheet."

Similarly, Pulte finished the first quarter with $1.1 billion in cash and is aiming to grow that to about $2 billion by the end of this year.

On the other end, Goldman Sachs analyst Chris Hussey recommends sitting out Hovnanian, whose shares are up 12% year-to-date through Friday, "until we see a greater improvement in the capital structure." Hovnanian recently announced plans to issue $600 million in debt to recapitalize its balance sheet and shortly before that it launched a secondary stock offering to raise cash. But Hussey says the latest move doesn't help Hovnanian's net debt-to-capital ratio, which is "one of the highest in the industry."

"If you're a retail investor you have to be very cautious and have a very long-term time horizon" to buy housing stocks right now, says Quincy Krosby, chief investment strategist at The Hartford, a financial-services company. "Within the group there are some good businesses and CEOs with experience. But you have to have patience because the unwinding process is painful."

On the bright side, this isn't the first boom-to-bust cycle, and in the past, housing stocks have recovered nicely. JMP Securities analyst James Wilson says he expects the sector to rebound as it did after the savings and loan crisis. Home-builder shares troughed in early 1991, with many falling 75% from 1989 peaks, Wilson said in a research report on March 25. But over the subsequent 18 months builder stocks surged a whopping 300% to 400%, before giving back just 30% to 40% of those gains.

The bottom line? Housing stocks surely aren't cheap on an earnings basis, because they're bound to lose more money in the near term. But if you want to wade in before the rest of the crowd does, be ready for more volatility and stick with the big builders that have cash.

Also See:

• Home-Builder ETFs Rally During Rocky Trading Session

• 5 Ways to Negotiate a Better Deal on a Home

• Fast-Growing Lowe's May Have Edge Over Home Depot