Share price as of Thursday's close:

$72.25

Share price now:

$77.25

Change:

6.9%

Volume:

9.7 million shares, daily average 2.7 million shares

Last time this high:

All-time high

52-week high:

$72.50

52-week low:

$30.64

Forward P/E before news:

8.8 (based on $8.21 a share)

Forward P/E after news:

8.1 (based on $9.48 a share)

HOUSING BUBBLE?

What housing bubble?

Shares of KB Home rose 7% to $77.25 on Friday after the home builder reported a 78% profit surge and blew the roof off Wall Street's expectations for the year. "Consumer demand in our market remains vibrant, fueling strong growth," said Chairman and Chief Executive Bruce Karatz in a statement accompanying the release.

No kidding. Late Thursday, the Los Angeles-based company posted net income of $181.5 million, or $2.06 a share, for the three months ended May 31, up from $102.1 million, or $1.20 a share, for the same period last year. Analysts tracked by Thomson First Call had a consensus estimate of $1.78 a share.

Revenue jumped 36% to $2.13 billion. Unit deliveries leapt 20%. The average selling price climbed 14% to $247,800.

As of May 31, the company's backlog of future revenue had climbed 52% to $6.79 billion. Total net orders rose 15% to 12,290, the highest quarterly level in the company's history.

With that kind of visibility, KB Homes raised its 2005 earnings forecast to $9 a share from previous guidance of $7.88. The new number represents a 58% jump from the $5.70 a share KB Home earned in 2004. All per-share amounts reflect the 2-for-1 stock split on April 28.

Gushing reviews from Bank of America Securities and Citigroup Smith Barney added to the euphoria that pushed the stock to its all-time high.

After raising his earnings estimates and pushing the target price to $82 from $70, Bank of America's Daniel Oppenheim wrote, "There may still be upside to estimates given that both our estimate and management guidance represent lower earnings growth than we've seen in the first two quarters of the year. [Also], we expect the company to update its previously stated goal of $10.00 per share in earnings in 2007 and expect management will indicate that 2007 earnings are likely to be significantly above that." (Oppenheim doesn't own shares of KB Home; Bank of America has an investment-banking relationship with the company.)

Stephen Kim of Smith Barney took it a step further and raised his rating to Buy from Hold on KB Home and five other builders: Beazer Homes, Hovnanian Enterprises, Meritage Homes, Pulte Homes and Ryland Group.

"Certainly the risks are greater today than a few years ago," says Kim, "But the fact of the matter is demand is not weakening. Margins will be higher over the next six to 12 months based largely on units they have already sold and are selling today. I think the estimates were way too low and that talk of a bubble alone does nothing more than create a temporary buying opportunity for investors who realize that the valuations already incorporate much of the risk." (Kim doesn't own shares of KB Home; Citigroup Smith Barney has a non-investment-banking relationship with the company.)

Kim doesn't buy comparisons between the housing boom and the late 1990s surge by telecom suppliers, which ended in tears and a fiberoptic glut.

"The bottom line is there are constraints in the industry, and that is different this time because we never had that before," says Kim of Smith Barney. "NIMBY [Not-in-my-backyard] and anti-growth sentiment have made it very difficult to build housing and that constraint is the reason why the housing bubble is grossly misunderstood and miscast constantly. A cyclical industry with no barriers to entry suddenly has barriers."

"The reason this isn't like the telecom bubble is because of the P/E," says Kim. "In 2002, the builders hit 8.5 times earnings, same in 2003. Earlier this year it was 8.7, and now its 8.4 times earnings. The P/E reflects as much negativity as you can hope as many people say we have a bubble. The consensus opinion is that the home builders aren't a great group or they wouldn't be trading at 8.5. But if it ain't the 'P/E,' then it's the 'E', and if these earnings come through as predicted, these stocks have to go up."

The Federal Reserve has been hiking short-term interest rates for a year now in an effort to contain inflation. But long-term rates are stuck near historic lows, ensuring easy mortgage terms. The resulting speculation has lately come in for intense criticism from central bank officials, with Federal Reserve Chairman Alan Greenspan complaining of "froth" and bubbles in certain local markets.

But builders have more going for them than low rates and solid job growth. Near-term demographics are also on their side as immigrants buy in and baby boomers go hunting for vacation homes.

KB Home was our One-Year Wonder at the end of 2003 based on the stock's 69% growth spurt that year. The share price has more than doubled since. It's risen more than sevenfold over the last five years.

"Every week that goes by I get more worried about what is going on," says Stephen East, an analyst at Susquehanna Financial Group, a brokerage based in Bala Cynwyd, Pa. "Everyone agrees it's hard to have a national housing bubble because the housing markets are local. Yet, there are bubble situations in certain markets such as California, Las Vegas and Florida. They're local, but these markets account for about one third of the housing in the U.S."

But East wouldn't sell housing stocks just yet. He says the listed home builders have six to nine months of revenue visibility, based on the time it takes to build a home.

Quote:
"This can't continue at the rate it's going," East says, reiterating his Neutral rating. "It eventually has to moderate to a more sustainable level. But no one knows how or when the boom ends, or slows down dramatically. And until you see signs that argue to step aside of these equities, you need to be in them if you are trying to outperform the market because their earnings power is outstanding." (East doesn't own shares of KB Home; Susquehanna Financial Group doesn't have an investment-banking relationship with the company.)