June 13, 2018

On Wednesday, the S&P 500 was down 0.4% and Toronto was down 0.1%.

The Federal Reserve Bank in the U.S. increased interest rates by the expected 0.25% and also apparently signaled that there will be two more rate increases by the end of 2018 and I understand three in 2019.

Toll Brothers was down 4.3% to $38.96. Reports indicate that Toll and other home builder companies declined after a report by a housing analyst company was released that suggests that orders for new homes are slower than normal this Spring. If new home orders do decline then I would still expect Toll Brothers to report good earnings for the next several quarters based on orders already on the books. But if orders start to decline year-over-year then forecast earnings will decline. At the moment the forward P/E on this stock of just 8.0 while the trailing P/E is 10.8. This mathematically suggests that analysts expect earnings per share to grow 35% in the forward period (2019) compared to the trailing period. Such a low forward multiple would appear to be based on an expectation of declining earnings after 2019.

To my understanding, houses remain quite affordable in the U.S. and housing starts are still well below the historic peak or trend levels. With jobs and incomes strong in the U.S., I thought that Toll Brothers would continue to grow earnings. Higher interest rates are a negative for that scenario but even at higher rates houses remain affordable in the U.S. to my understanding. Hopefully, the next data point will be more positive. Meanwhile, I suspect Toll Brothers is actively buying back shares.

Linamar was down 1.8% to $62.47. This is no-doubt due to trade war fears. According to Yahoo Finance the trailing P/E is 7.4 and the forward P/E is 5.9. On that basis the analysts are predicting a 25% earnings increase for the forward number (2019?) but perhaps the market then expects earnings to decline after that.

Granted analysts earnings tend to be biased high in the forward period (generating low P/E ratios) and granted that both Toll and Linamar are cyclical companies but it seems somewhat hard to believe there is an expectation of robust earnings growth for a year followed by declines big enough to explain the low forward P/E ratios.