It’s fairly simple: buy the builders trading below book value (Beazer, CHCI, etc, etc) and short an appropriate amount (i.e. buy puts on) of the Case-Shiller housing price index.
The thesis is as follows: several of the builders are trading at mere fractions of book, largely due to the fact that investors anticipate plenty more writeoffs of inventory, consisting of unsold homes and land, going forward. This inventory comprises the vast majority of these companies’ tangible asset values, so it naturally makes sense that discounts to book are largely due to fear that the asset values are overstated. Normally I’d simply buy and hold such cheaply priced companies, but the truth is that I haven’t a clue where housing prices are headed going forward or how much in charges to inventory the builders will take.
What I do know is that a company like Beazer Homes (BZH), for instance, has a geographically diversified portfolio of decidedly normal homes which I believe, on average, to be well-representative of the typical American house. The average unit price is listed on the company’s books at around $220,000, and, interestingly, the average composite home price can be shorted via Case-Shiller at around the same price.
This means a savvy investor can effectively profit from the spread/discrepancy between book value and price of Beazer’s stock by hedging out the writedown risk via a short position in the Case-Shiller composite. While I’m not positive, I’m fairly confident that an inefficiency in the smaller homebuilders’ pricing exists since most investors are not considering how they can come close to eliminating the risk of writedowns. Of course, this is assuming that investors are also willing to stomach the risk of heavy debt, poor management, etc., but for some it may be worth these risks.
Note: I do not currently have a position in Case-Shiller futures or any homebuilding stocks.