For homebuilding firm Toll Brothers (NYSE:TOL), it’s important to give credit where it’s due. Despite enormous pressures related to affordability, the company – along with the underlying sector – has performed exceptionally well. Unfortunately, all good things must come to an end. Specifically, Toll appears to face a trifecta of pain, which may undo its previous good work. As a result, I am bearish on TOL stock.
Options Market Doesn’t Bode Well for TOL Stock
To get right into it, the first major headwind stems from the options market. Generally, retail investors should pay attention to this space as it represents the actions of the so-called “smart money.” With TOL stock, the net sentiment found regarding its options flow warrants closer examination.
Interestingly, the most recent big block trade (likely made by an institutional investor) occurred on September 12. A trading entity or wealthy individual trader bought 1,000 contracts of the Dec 15 ’23 60.00 put, paying a premium of $75,000. On the following day, TipRanks’ options price history for this call showed a net increase in open interest of 1,000 contracts. Therefore, it’s likely that the trader anticipates TOL stock to descend.
So far, it has been a prudent action. Since the close of the September 12 session, TOL stock has fallen by more than 9%. To be fair, the stock last closed at $72.61. In other words, the trader placing this bearish wager appears fairly confident that the home builder will continue slipping.
Rising Days Inventory Clouds Toll Brothers
While the options data may be insightful, it’s not the end-all, be-all. To be sure, the smart money – even the institutional investors with their access to the best information and resources – can make mistakes. However, what makes the above bearish wager compelling is that it aligns with financial realities, particularly rising days inventory outstanding (a measure of how long inventory is held before being sold).
In Fiscal Year 2020 (ending October), the days inventory outstanding count for Toll Brothers hit nearly 501 days. The following year, the metric slipped to 415, then down to 390 the next year. Naturally, the erosion in inventory reflects heightened demand for housing amid the flurry in competition.
However, on a trailing-12-month (TTM) basis, days inventory outstanding has risen to almost 422 days. This figure by itself doesn’t raise much alarm. However, under the context of a rising affordability crisis, the data point is instructive. Increasingly, individual prospective homebuyers lack the capital to acquire homes, putting pressure on investments like TOL stock.
A Hawkish Fed Doesn’t Help Matters
Completing the trifecta of pain for Toll Brothers is the Federal Reserve. While the normalization process from the COVID-19 crisis has been a much-desired one, it came at a price. Due to the monetary and fiscal excesses associated with the pandemic, Americans have struggled with the ensuing inflation. To address this other crisis, the Fed has increased the benchmark interest rate, effectively robbing Peter to pay Paul.
To be fair, the central bank kept interest rates steady following its latest meeting, aligning with expectations. What’s more, policymakers framed the overall picture in a relatively positive light. Their statements implied that a soft landing for the economy is possible. Obviously, that’s good news if true.
However, the Fed also left the door open for one more interest rate hike before the year is over. Looking at other risk-on asset classes – particularly cryptocurrencies – it appears that investors are rotating their money away from volatile markets. And that also appears to be the sentiment for TOL stock, given the recent bearishness in the options market.
Plus, investors should be reminded that the Fed does not guarantee a soft landing. With traders responding to both pessimistic fundamental and financial factors, retail investors should be vigilant.
Is TOL Stock a Buy, According to Analysts?
Turning to Wall Street, TOL stock has a Moderate Buy consensus rating based on 11 Buys, three Holds, and two Sell ratings. The average TOL stock price target is $94.07, implying 29.6% upside potential.
The Takeaway: Don’t Ignore the Cautionary Winds Against TOL
To be sure, no one indicator represents a guarantee that a security will move in a particular direction. Further, not even a series of indicators pointing in the same direction offers a guarantee of anything. However, the probability that TOL stock may be in trouble is arguably high.
With outside factors such as inflation and rising interest rates negatively impacting Toll Brothers’ financials, causing its days inventory outstanding metric to rise, major options traders seem to have made their decisions. Thus, retail investors should approach TOL cautiously.
