Home-builder stocks are pricey by one classic valuation metric. Yet there may be reason for investors to look befyond book value.

Builder shares stumbled this past week after PulteGroup (ticker: PHM) said that supply-chain issues would result in about 1,000 fewer homes closed in 2021 than previous guidance suggested. Across the industry, shortages of materials and labor have resulted in a significant count of homes authorized to be built but not yet started.

But those supply-chain headwinds will work themselves out, Wedbush analyst Jay McCanless says, adding that builders will eventually be able to close plenty of homes. He views recent weakness as a buying opportunity.

Declining home-buyer sentiment hasn’t helped shares of the companies, and neither have fears of higher mortgage rates. But inventory remains tight as younger buyers enter the market. Morningstar estimates that 3.8 million units are needed to meet demand.

“There is an economic need that’s going to take 10 years to fill,” said Bill Smead, chief investment officer of Smead Capital Management.

Still, builder stocks look expensive based on price-to-book ratios, long a preferred valuation metric for the group because it accounts for assets such as land. Two of the three largest builders, D.R. Horton (DHI) and NVR (NVR), recently traded at or above two times book value, the point at which some say it’s time to sell.

When it comes to builders, book value may no longer be the only metric to look at. These three stocks look historically cheap based on current price/earnings. Plus, analysts see double-digit gains ahead.

But other metrics could become more telling as the industry’s largest builders continue to generate cash, says BTIG analyst Carl Reichardt, who adds that enterprise value to Ebitda (earnings before interest, taxes, depreciation, and amortization) or free cash flow yield could become more appropriate ways to evaluate builders.

Price/earnings ratios also illustrate the disconnect. While the four builders in the S&P 500 home-building subindex trade at 5.4% above their five-year average book value, they trade nearly 25% below their five-year average P/E ratio. With an average P/E ratio of 8.3 times forward earnings, they are also far cheaper than the S&P 500 index.

“There is an economic need that’s going to take 10 years to fill.”

— Bill Smead, Smead Capital Management
Take D.R. Horton as an example. The largest public builder, more than half of all its homes closed in the 12 months ended June 30 were priced below $300,000. “They are the premier player to the first-time home buyer,” says Smead, whose Smead Value fund counts D.R. Horton among its holdings.

Horton trades at 2.3 times book value, higher than its five-year average of two times. By P/E, however, the builder looks cheap, trading at 6.9 times its next 12-month earnings.

The company reported a 78% year-over-year increase in earnings per share in its latest quarter, and analysts expect further gains, with projected consensus per-share earnings of $11.21 in fiscal 2021, which ends in September, and $13.10 in 2022. Horton offers a dividend yielding 0.9%.

Among medium-size builders, M.D.C Holdings (MDC) and Meritage Homes (MTH) also trade above long-term book values and below long-term P/E ratios.

M.D.C., a build-to-order builder with a $3.6 billion market cap, focuses on entry-level and first-time move-up buyers. The builder operates primarily in the West under the name Richmond American Homes, and announced an expansion to Boise, Idaho, and Nashville, two fast-growing markets.

M.D.C.’s footprint is appealing as high demand outstrips supply in its core markets, Raymond James analyst Buck Horne wrote in an August report.

Analysts expect full-year earning to grow to $8.56 a share in 2021 from $5.17 in 2020, a 66% increase. The consensus calls for a further increase to $10.04 in 2022. The stock trades at 5.3 times earnings and yields 3.1%.

Meritage, which operates in 17 markets across the Southwest, Southeast, California, and Texas, has seen its sales mix shift significantly over the past two years. In the latest quarter, entry-level homes expanded to 81% of the builder’s mix from about half that two years prior.

The builder is focused on increasing its market share, with a goal of boosting its community count to 300 by next June, up from 226 in July 2021.

The company’s expansion goal “dwarfs peer growth rates,” Wolfe Research analysts Truman Patterson, Paul Przybylski, and Trevor Allinson wrote in August. They upgraded the stock to Outperform.

The builder’s home deliveries are expected to increase from 11,834 in 2020 to 12,860 this year and 14,805 in 2022. Per-share earnings are expected to increase 72% in 2021 to $18.88, and to $21.80 in 2022.