Home Builders Tempting, but Not for Faint of Heart

The stocks of several major home builders are breathing new life lately. Shares of Toll Brothers (TOL), Lennar (LEN), Pulte Homes (PHM), Hovnanian Enterprises (HOV) and D.R. Horton (DHI) 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.