There’s an ETF that has surged to gains of over 30% year-to-date, and believe it or not, it’s not a tech or AI ETF. In fact, it’s an ETF that focuses on what many might perceive as a slightly less exciting segment of the economy (or at least not as exciting as large language models and generative AI) — home construction.
That’s right, the SPDR S&P 500 Homebuilders ETF (NYSEARCA:XHB) from State Street is up 27.6% year-to-date. Here’s why it could still have room to run even after this impressive performance so far in 2023 and why it could be an interesting addition to portfolios.
What Does the XHB ETF Do?
The SPDR S&P 500 Homebuilders ETF is part of the popular SPDR series of ETFs from State Street (NYSE:STT), which all invest in specific sectors and subsectors of the S&P 500 (SPX). As you can guess from the name, XHB invests in an index composed of companies involved in the construction of new housing, the S&P Homebuilders Select Industry Index. The ETF has $1.3 billion in assets under management and features an expense ratio of 0.35%. XHB pays a dividend that currently yields 0.9%.
Why is XHB Up So Much This Year?
Why is XHB on such a tear in 2023? Part of the answer is simply a reversion to the mean. The ETF had an ugly 2022, losing 28.9% of its value for the year, as the rising-interest-rate environment caused mortgage rates to spike, hurting demand for new housing, while the inflation of prices for building materials didn’t help matters either.
The sentiment was so bad that not only did the ETF lose nearly 30%, but many top home builders were trading at price-to-earnings multiples in the low single-digits. When things get that bad, opportunistic buyers can come in and wait for the situation to improve, which is essentially what is happening in 2023.
Homebuilders got a surprise jolt in June when the Census Bureau reported that housing starts surged 21.7% month-over-month in May to 1.63 million, well above the consensus expectation of 1.4 million. Both inflation and the supply-chain bottlenecks that constrained the industry going back to the pandemic seem to be ameliorating, which bodes well for home builders in the short term.
Longer term, the industry should benefit from the fact that there is a significant housing shortage in the United States. In May, a new study from Realtor.com found that between 2021 and 2022, the disparity between household formations and single-family home construction increased to a staggering 6.5 million homes. In order for this gap to decrease, the services of the companies that XHB owns will continue to be needed for a long time to come.
A Balanced Portfolio
XHB only has 37 holdings, but it is fairly diversified in that its top 10 holdings account for only 38.6% of the fund, so this is a well-balanced ETF. Home builder Lennar (NYSE:LEN), XHB’s top position, has a weighting of only 3.9%.
Below, you’ll find an overview of XHB’s top 10 holdings from TipRanks’ holdings tool.
While major home builders Lennar and Pultegroup (NYSE:PHM) are in the top three, you’ll see that the ETF isn’t limited strictly to companies that construct homes.
Suppliers to the industry, like HVAC manufacturers and distributors Carrier Global (NYSE:CARR) and Trane Technologies (NYSE:TT), are also key components, as are Owens Corning (NYSE:OC) and Builders Firstsource (NYSE:BLDR), which are major suppliers of materials used in the home building process. Even home improvement retailer Lowe’s (NYSE:LOW) features here.
While many of these companies are up big year-to-date, they are still cheap in comparison to the broader market. The average P/E ratio for the stocks that XHB holds is just 11.9. While these stocks are no longer trading at single-digit P/E multiples, this is still a sizable discount to the broader market — the S&P 500 currently trades at about 20 times earnings.
Despite these modest valuations, as you can see on the chart above, XHB’s holdings feature some fantastic Smart Scores across the board. The Smart Score is a proprietary quantitative stock scoring system created by TipRanks. It gives stocks a score from 1 to 10 based on eight market key factors. A Smart Score of 8 or higher is equivalent to an Outperform rating.
Six out of XHB’s top 10 holdings feature Smart Scores of 8 or higher, led by Pultegroup, Carrier Global, and Trane Technologies, which all have ‘Perfect 10’ scores. XHB itself has an ETF Smart Score of 8.
Surprisingly Strong Past Performance
Homebuilding has a reputation as a highly-cyclical business, so it is somewhat surprising to see that it has generated strong returns for its investors over a variety of time frames. As of the end of May, XHB had a red-hot three-year annualized total return of 18.8%, putting it in the same league as many of the hot tech ETFs that get a lot more press.
Over the past five years, returns were still impressive, coming in at 13% on an annualized basis. Over the past 10 years, the ETF had a still solid but not as spectacular annualized return of 9.2%.
Is XHB a Buy, According to Analysts?
Turning to Wall Street, XHB has a Moderate Buy consensus rating, as 51.8% of analyst ratings are Buys, 39.3% are Holds, and 8.8% are Sells. However, at $80.10, the average XHB stock price target implies just 0.4% upside potential.
While XHB has rebounded strongly from its lows and has soared in 2023, the ETF could still have more room to run. Valuations for its holdings are still cheap relative to the broader market, and several of its top holdings feature fantastic Smart Scores.
Looking at the big picture, the short-term outlook for homebuilders looks improved thanks to cooling inflation and easing supply-chain constraints, and the long-term demand outlook for the industry looks robust based on the continued and significant shortfall of new housing in the United States.