AV Homes: A Cheap Stock With Rich Potential

With the market near a record high, it takes extra effort for a value investor like me to find promising stocks. So when I was recently assigned to write a piece about attractive stocks selling for single-digit prices, I was determined to search broadly. I ended up looking at about 75 companies and eliminated all but eight.

Sorry prospects or high valuations quickly nixed most of the candidates. But a small homebuilder got cut for a different reason. In the weeks that it took to put together my story, the share price of AV Homes (symbol AVHI) soared above $10 and made the stock ineligible. After conducting some research, I bought 1,000 shares at $11.90 apiece for my Practical Investing portfolio.

AV Homes was a bit of a jack-of-all-trades in the early 2000s. It sold title insurance, offered cable-TV services and operated a small water utility. But its main business was real estate. The company developed communities for the 55-and-over set as well as industrial and commercial properties, primarily in Florida and Arizona, where it is based. The firm generated stellar revenue and profit growth from 2002 through 2006. But the Great Recession hit the Sunbelt hard, and AV lost money every year from 2008 through 2014.

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The stock, which peaked just shy of $85 in 2007, slid below $6 in 2011, when AV reorganized to focus on residential development. When I discovered AV in February, it traded for a hair under $10, but the stock popped some 20% in the weeks after the firm issued fourth-quarter results, which featured a doubling in revenues and a ninefold increase in earnings from the same period in 2014. Plus, AV reported its first yearly profit since 2007. First-quarter results were equally impressive, with big gains in every important measure, from the number of dwellings sold to average selling prices and, of course, profits and revenues.

To learn more, I tapped my Arizona contacts to find people who had bought AV homes. Linda Baldwin, a physician’s assistant who bought into AV’s Encore development in Mesa, Ariz., last December, is still waiting for some fixes to the home, but she has no regrets about the purchase. “On Tuesday, I play dominoes. Wednesday is bocce ball. Saturday, they had a concert,” she says. “I love the people. We have a travel club and a book club and an arts and crafts center. I’m having a blast.”

Big-tech stumbles. Analysts expect AV’s earnings to double in 2016 and jump another 50% in 2017. That said, it’s wise to be skeptical of earnings estimates, particularly in the late stages of an economic expansion. Disappointing results in April from Apple (AAPL), which I hold in the Practical Investing portfolio, and Microsoft (MSFT), which I just sold, underscore the point. In both cases, earnings for the January–March quarter came in well below analysts’ forecasts, and the stocks tanked.

Short-term price drops rarely rattle me, but I worry about stocks that have reached lofty valuations thanks to what appear to be rosy projections. That’s the main reason I sold my Microsoft shares. Even after the decline, the stock, at $50, sells for 19 times projected year-ahead earnings, which seems too high for a company with only moderate growth and leaves the stock vulnerable to another spill if there’s more disappointing news.

Apple and AV both trade for about 10 times estimated earnings. That, in my view, creates a margin of safety that should allow the stocks to shrug off a few quarters of subpar results. I don’t know when the bull market might end, but when it does, I expect stocks selling for modest price-earnings ratios to provide some shelter from the bear market that follows.