One Investor's House Party

The smartest guy in real estate isnt necessarily the neighbor who used his home equity to leverage into a second home, which promptly doubled in value. We all have one of those lucky neighbors, and thats an impressive result, for sure. But it doesnt come close to the real estate home run that mutual fund manager Ron Muhlenkamp hit. He wasnt buying homes before they took off; he was buying the stocks of companies that build them. Since he jumped into housing stocks in 1999-2000, his favorites have increased sevenfold and—pay attention—Muhlenkamp is still buying.

Imagine that. He started buying Beazer at $8 a share and has held on while it soared to $69; Centex at $10, now $68; Meritage at $3, now $59; NVR at $60, now $759; Pulte at $5, now $37; Toll Bros. at $10, now $32. Theyre still dirt cheap, Muhlenkamp told TIME.

Homebuilder stocks account for 20% of his portfolio, and the only selling hes doing is to prevent housing from swamping his other holdings as prices shoot higher. This is remarkable in light of indisputable evidence that the housing boom is at last slowing. Existing home sales plunged 5.7% in December and the median home price edged 1.9% lower, the government recently reported.

People have been telling me that theres a bubble, and that Im crazy, since 02, says Muhlenkamp, a dyed-in-the-wool value investor whose Muhlenkamp Fund is one of the few that has outperformed the legendary Bill Miller at Legg Mason Value Trust over the past 15 years. As long as people think Im crazy, Ill own [these stocks]. Thats what keeps them cheap.

The story is fairly simple, in Muhlenkamps view. Even after their blistering runups, the builder stocks sell for just eight times earnings per share—less than half the markets overall multiple of 18. New orders are clearly slowing, and may fall as much as 5% this year. But even at that rate the big homebuilders can prosper. As a group, theyve increased their share of the market from 10% to 25%—at the expense of small builders—over the past 15 years, and that share could easily go to 35% or more. Meanwhile, this years earnings are practically in the bank because builders have a large enough backlog to stay busy into the summer.

So what could go wrong? Mortgage rates could spike and buyers could walk away from their deals. But with the economy slowing and the Feds rate hikes near an end, that seems unlikely. These stocks wont continue their torrid run indefinitely, but Muhlenkamp believes they will continue to rise. If hes right on this group—and he has been for half a decade—the occasional pullback should be viewed as an invitation to join his house party.