Metric sales

This metric alone reveals trouble ahead

If home builder Toll Brothers (NYSE: TOL) had the chance, he would probably like to bring the calendar back to 2021. At that time, many real estate experts suggested that, if possible, potential buyers should pull the trigger since inflation will continue to rise. Recently, however, the Federal Reserve has poured cold water on this thesis, suggesting that the opposite framework may be true. Now, an inventory metric reveals that things may not be going well in the future. Therefore, I am bearish on the TOL stock.

Despite some emerging signs that companies such as Toll Brothers may need to revise their valuations, the mainstream media still presents a bullish picture from a door-to-door sellers’ perspective. For example, just a few days ago, TIME issued a warning that those waiting for the housing market to crash should not hold their breath, experts in the field say.

Even more confusing to those watching TOL’s stock, the underlying company continues to post encouraging financial results. The luxury homebuilder has released its third quarter results (ending July 31, 2022).

Adjusted for one-time items, TOL posted earnings per share of $2.35, beating Wall Street’s consensus estimate of $2.30 per share. In the prior year period, Toll earned $1.87 per share. In the past four quarters, the homebuilder has exceeded estimates four times.

On the revenue side, Toll reached $2.49 billion, beating the consensus target by 0.37%. The company also beat its own tally from a year ago (sales of $2.26 billion). Similar to the earnings trajectory, Toll has exceeded consensus estimates for revenue four times out of the last four times.

Based on the above statistics, market watchers might be tempted to bid on TOL shares. However, the glaring detail is that the stock has lost 37% of its market value since the start of the year. In addition, over the past month, the TOL has decreased by 7%. Therefore, the story is not as compelling as the third quarter results would suggest.

Nevertheless, on TipRanks, TOL has a Smart Score rating of 8 out of 10. This indicates moderate potential for the stock to outperform the market as a whole.

Stock TOL and Days Remaining Inventory Issue

Although TOL stock looks encouraging from the current snapshot of events, the market is a forward-looking arena. Therefore, it is not about what is now but rather what is likely to be in the future. In this setting, Toll Brothers may not be attractive to most investors, and a lot of that has to do with the company’s Days Left Inventory (DIO). This metric is used to estimate the average number of days a business holds inventory before finding a buyer.

For Toll’s fiscal year ended October 31, 2019, it featured a DIO metric of 498.5. A year later, days-in-circulation inventory increased only slightly to 500.8. However, with inflation rapidly eroding the purchasing power of the dollar, this line item fell sharply to 415.1.

Naturally, as people competed in unprecedented bidding wars, Toll Brothers and the like started selling their wares at an aggressive rate. For context, in fiscal year 2007, the company had a days outstanding inventory of 517.25.

Circumstances have deteriorated so badly (in terms of inventory levels) that this metric fell to 315.7 in the fourth quarter of fiscal 2021. However, the paradigm is changing. In the following Q1 2022 fiscal report, Toll disclosed a DIO of 541.94, representing an increase of nearly 72% quarter over quarter.

Granted, the metric fell to 441.48 in the latest Q3 report. Nonetheless, the trend is clear: the DIO as a whole is rising, reflecting a major pivot in the underlying economy.

The Fed changes the rules

Towards the end of August, Fed Chairman Jerome Powell delivered his policy speech at the annual economic symposium in Jackson Hole, Wyoming. Acknowledging the multi-decade highs in inflation, Powell reiterated the central bank’s commitment to tackling soaring consumer prices.

According to the official transcript, the Fed Chairman said the following. “Restoring price stability will take time and will require using our tools forcefully to better balance supply and demand. Reducing inflation will likely require an extended period of below-trend growth.

“In addition, there will most likely be an easing of labor market conditions. Although higher interest rates, slower growth and looser labor market conditions will reduce inflation, they will also cause hardship for households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.

Investors must enter two central admissions. The Fed understands that controlling runaway inflation will take time. Second, Powell acknowledged that raising the benchmark interest rate would cause hardship for households and businesses.

In other words, the paradigm of generally accommodative monetary policies – exceptions, of course, exist – that has been in place for decades will change and change dramatically. Going forward, hawkishness will dominate the day, which does not support risky investing or risky behavior.

As a result, TOL stock now finds itself on the wrong side of the economic and monetary spectrum.

Is TOL a good stock to buy?

As far as Wall Street is concerned, TOL stock has a moderate buy consensus rating based on four buy, seven hold and zero sell ratings. The average TOL price target is $53.33, implying an upside potential of 17.6%.

Conclusion: Recognize the signs

Just as the Fed Chairman recognizes the signs of what he needs to do to control inflation before it becomes an insurmountable crisis, investors must also realize that the framework for TOL stocks has changed. With the incentive structure no longer in favor of buying real estate (at high prices), it’s probably time to move away.

Disclosure