Today, shares of Toll Brothers (TOL) shot up nearly 9% after the homebuilder posted better-than-expected results for the second quarter. This was especially surprising, because Toll Brothers has missed estimates for two of the past three quarters. However, for those of you looking to add TOL, you’ll want to read on: I can think of at least five reasons why I wouldn’t recommend buying the stock now.
First, let’s look at the results that sparked the rally. Compared with Q2 2015, Toll Brothers’ net income jumped 31.2% year-on-year to $89.1 million, or $0.51 per share. Analysts were looking for $0.46 EPS, so Toll Brothers posted a 10.9% earnings surprise. Over the same period, revenue climbed 31.5% to $1.12 billion. This beat the $1.04 billion consensus estimate by 7.8%. Looking ahead to FY 2016, Toll Brothers expects to bring in between $4.76 billion and $5.36 billion in revenue. This is in line with the Street view.
Now, I can understand why the strong sales and earnings beat would drum up interest in Toll Brothers. However, there isn’t enough evidence yet of a definitive turnaround for TOL. In the meantime, here is what is working against the stock.
1. It trades at a premium to its competitors.
TOL currently trades at 14 times trailing earnings, and 9 times forecasted earnings. While that’s not exorbitant, that’s on the higher end of the Residential Construction industry. DR Horton Inc. (DHI), Lennar Corp. (LEN), PulteGroup Inc. (PHM) all have lower current P/E ratios.
2. There is little buying pressure for the stock.
If you plug TOL into Portfolio Grader, you’ll see that it earns an F-rating for its Quantitative Grade. This is crucial, because the Quantitative Grade measures the current level of buying pressure supporting a stock. Think of buying pressure as “following the money.” The more money that floods into a stock, the more momentum a stock has to rise. So with its F-rating, TOL doesn’t have a lot of upside potential.
3. Its forecasted earnings aren’t all that great.
This year, the analyst community expects Toll Brothers’ EPS to climb just 7.3% over FY 2015. By comparison, DR Horton Inc. and PulteGroup are expected to grow earnings by 39.5% and 23.5% respectively this year.
4. On that matter, its overall fundamentals are mediocre.
My Stock Report page for TOL also reveals that it earns a C for its Fundamental Grade. This is due to minimal sales growth, a poor track record of earnings surprises and lackluster earnings growth, operating margin growth and analyst earnings revisions. While some of these grades may firm up once the latest results are plugged in, Toll Brothers has lost a lot of ground against its competitors. D.R. Horton, Lennar Corp. and PulteGroup all have B-rated Fundamental Grades.
5. It doesn’t pay a dividend.
To add insult to injury, TOL doesn’t even pay a dividend, when DHI, LEN and PHM all do.
For these reasons, I currently consider TOL a D-rated sell. If you currently own TOL shares, you may want to consider selling them into strength.