Why Toll Brothers Shares Dipped After a Huge Profit Pop

Homebuilding is one of those bellwether industries -- sensitive to changes in the economic environment, real or perceived. And recently, in the housing market, things have been looking a bit less than hunky-dory. Thus, Wall Street's response to Toll Brothers' (NYSE: TOL) fiscal fourth-quarter report was less about the high-end homebuilder's recent strong results, and more about a slowdown in real estate. The company's new-home orders declined for the first time in four years.

In this segment of the MarketFoolery podcast, host Chris Hill and senior analyst Emily Flippen discuss the rising interest rate environment, the power of consumer sentiment, media blaming, and more in connection with the state of the real estate market broadly, and Toll Brothers in particular.

A full transcript follows the video.

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This video was recorded on Dec. 4, 2018.

Chris Hill: Let's start with Toll Brothers. Fourth-quarter profit up 62%. That's the headline. And if that was the only thing that mattered, then you'd be very confused by the fact that the stock was down. The stock's not down as much as it was. It's down about 1.5% right now as we came into the studio. It was down a bit more earlier. When you look at what's going on with the Toll Brothers, what do you see?

Emily Flippen: We're looking at the housing market in general, and a smaller part of that housing market, the niche, high-end, very expensive housing market. I think the reason why we're seeing the now-small decline, what was a very large decline, is just because of the fact that, that was the first fall in quarterly order orders in four years. They were hit by those rising interest rates, homes now not as affordable as they once were for the average person, at least. While their backlogs and deliveries are still very high, there's now a little bit of investor fear about whether or not that's going to be continued for the next few years.

Hill: Some of that fear was touched on by Toll Brothers itself in their statement. I'll just quote directly from the earnings release. "In November, we saw the market soften further, which we attribute to the cumulative impact of rising interest rates and the effect on buyer sentiment of well-publicized reports of a housing slowdown." Kudos to whoever on the communications team at Toll Brothers who said, "Let's use the tried-and-true playbook of blaming the media." There's a little bit of blaming the media when it comes to that. But to your point, it would just be crazy to ignore the reality.

Flippen: Yeah. You can blame the media all you want, but ultimately homebuilding is still one of the leading indicators of change in a business cycle. It's natural, when people see these houses stop being built, construction slowing down, to be a little bit afraid, because it is a leading indicator. I think it's silly to push it back on the media and investors in particular, especially because investor sentiment, while you can scoff at it all you want, does cause recessions, does cause economic turndown, and does affect your company. So it's interesting to see that dichotomy between the way their PR people act and what's actually happening in the market.

Hill: As an investor, are the homebuilders as a group a way that you're interested to invest into the housing market? Or are there other ways? It seems like, for anyone who's looking at the housing market as an investor and thinking, "OK, this is a huge industry, there are a lot of ways to invest in it," it seems like investing directly in the Toll Brothers of the world is an intermediate level of difficulty.

Flippen: I would agree with that. You have people who are really bullish on real estate who like to get in on the ground-level real estate, people who might buy into something like Toll Brothers, or people who buy into companies that maybe own a lot of their stores, so they own a lot of real estate, but don't act in real estate directly. There's lots of different ways to get involved.

For me as an investor, it's important to remember two things. The first thing, I personally, and I think everyone here at the Fool, has a very long time frame that they're investing for. You also have to be aware of the economic conditions of when you're investing. We are looking at a slowdown in the housing market, and there might be a pullback sometime in the future, I think that's inevitable. Business cycles are a natural thing that happens. If you're a long-term investor, hopefully you're aware of that, and you're not going to panic when that fall does inevitably come.

Chris Hill has no position in any of the stocks mentioned. Emily Flippen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.