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June 22, 2012

Stock of the Day

Recommendation: B-rated Buy

Welcome to the Stock of the Day for June 22, 2012. It is becoming clear that the housing market bottomed out and is on the rise again. Housing prices have risen almost 8% in the past year, in May building permits reached a four-year high and homebuilder confidence has hit a five-year high! This creates a great buying opportunity for home builders like Toll Brothers Inc. (TOLL), so let's review this stock (and some of its biggest rivals) and see whether you should buy into the housing market recovery.

Company Overview: Based in Pennsylvania, Toll Brothers is the fifteenth largest homebuilder in the industry. This company is known for its luxury homes, drawing in $1.5 billion in revenue in the most recent fiscal year. With operations across dozens of major suburban market and metropolitan areas, this company has its finger in several pots, including land developing, golf course management, landscaping services and even mortgage services.

Competition Buzz: There are three Residential Construction companies that Toll Brothers really needs to compete with: DR Horton Inc. (DHI) and Pulte Homes Inc. (PHM), two of the largest homebuilders in the U.S., Hovnanian Enterprises Inc. (HOV), a real estate powerhouse that deals with every aspect of marketing homes. Of these four companies, D.R. Horton receives the highest grade in my Portfolio Grader tool, and that's because its fundamentals are the strongest. Toll Brothers isn't far behind, but D.R. Horton comes out on top in terms of sales growth, operating margin growth and earnings growth. Interestingly enough, all four companies are struggling with their cash flow and return on equity. Toll Brothers' claim to fame is that it has the highest Price/Earnings to Growth ratio in the industry.

Earnings Rundown: After posting strong operating results for the second quarter, including 17% sales growth and a whopping 150% earnings surprise, it looks like this company is headed towards another strong earnings announcement. Now, one thing to know about this company is that it has a history of wild earnings surprises; the company has beaten earnings estimates by an average of 191% in the past four quarters! This quarter, the company is expected to post 28% sales growth, but its profit is expected to decline 32%. At this point in the game I'm not worried about the earnings dip for two reasons. First being the company's tendency to trump estimates, and secondly because in the past month analysts have upwardly revised their estimates by 21%. These kinds of analyst earnings revisions tend to precede strong earnings surprises. In any event, the next earnings announcement won't come for at least two more months so there is plenty of time for analysts to change their tune.

Current Ratings: Before you buy any stock, you should always run it through my free Portfolio Grader ratings system. In the past year, this stock has improved significantly; as recently as last September TOL was a D-rated sell. Since then, the company has firmed up its fundamentals, especially in terms of its earnings momentum, track record of beating earnings estimates as well as analyst earnings revisions (which are all A-rated). TOL also receives a B in terms of sales growth and operating marging growth, but it could stand to improve its earnings growth and cash flow.

Bottom Line: As of this posting, June 21, I consider TOL a B-rated buy.

Sound Off: What do you think about TOL? Are you a buyer at current prices?

Would you like to check the fundamentals backing up one of your stocks? For more stock grades, please visit my Portfolio Grader website!

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