Toll Brothers, Inc.’s (TOL Quick QuoteTOL - Free Report) shares experienced a 21.7% rally in the past six months compared with the Zacks Building Products - Home Builders industry’s 16.4% growth. The stock has also performed better than the broader Construction’s 6.5% rise and the S&P 500’s 9.3% increase in the same time frame. This impressive performance stands out in the construction sector, reflecting a broader recovery trend and benefits from the limited supply of new and existing homes at affordable prices and favorable housing demand demographics.

This Fort Washington, PA-based homebuilding company is benefiting from a balanced approach that includes speculative (spec) and build-to-order (BTO) methods to drive growth. Toll Brothers’ focus on affordable luxury communities and strategic land acquisition strengthens its market position. The lack of competition in the luxury housing segment provides a competitive advantage, further supporting its expansion. This strategy, combined with its ability to offer quick move-in and personalized homes, fortifies TOL’s position in the evolving housing market.

Toll Brothers generated strong third-quarter fiscal 2024 financial results. Its quarterly earnings per share (EPS) of $3.60 surpassed the Zacks Consensus Estimate by 9.8%. Revenues in the said quarter totaled $2.73 billion, beating the consensus mark by 1.2%. The company delivered 2,814 homes at an average price of $968,000, generating record third-quarter home sale revenues of $2.72 billion. The adjusted gross margin was 28.8%, exceeding guidance on improved homebuilding efficiencies and a favorable mix. It also raised its full-year delivery guidance, which is currently anticipated to be between 10,650 and 10,750 homes, with projected homebuilding revenues of $10.4-$10.5 billion. (read more: Toll Brothers Q3 Earnings & Revenues Beat, FY24 View Up)

TOL’s 6-Month Price Performance

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TOL Stock Trades Above 50- and 200-Day Moving Averages

TOL currently trades above the 50- and 200-day simple moving averages. While the stock price experienced a significant surge, benefiting from positive market conditions and strong fundamentals, investors need to assess whether this growth is sustainable or if it’s time to reconsider their position.
 

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The company’s shares have demonstrated resilience and potential. With various factors influencing its trajectory, a deeper dive into its performance drivers and future outlook is necessary.

Key Fundamentals Supporting Toll Brothers' Stock Growth

Focus on Affordability and Luxury Market: Toll Brothers primarily offers luxury homes in affluent suburban areas with convenient access to major cities. Its luxury communities are located in high-growth and high barrier-to-entry markets. A strong brand, a wide range of home prices and a BTO model provide it with a competitive advantage. Catering mostly to luxury move-up buyers who are less sensitive to price changes, Toll Brothers benefits from greater pricing power compared with other homebuilders.

During third-quarter fiscal 2024, TOL witnessed strong demand on the back of favorable demographics, as many millennials are buying their first homes later in life with higher incomes. The company is optimistic and expects older millennials, now entering their 40s, to boost its luxury move-up business over the next decade.

Toll Brothers' strategy of expanding its price range to include more affordable luxury homes and increasing the supply of spec homes boosted market share. This approach shortens cycle times, improves inventory turnover and optimizes fixed costs, leading to revenue growth and higher operating margins. With these strategies and a more capital-efficient land approach, TOL is positive about attractive returns in the future. It expects strong demand for new homes to extend through the end of fiscal 2024 and into 2025, supported by mortgage rates at their lowest in a year, favorable demographics, and a balanced housing market.

TOL's Balanced Operating Model: Toll Brothers is balancing spec and BTO methods to fuel growth. It offers customization through BTO options to cater to customer preferences and needs, like other homebuilding companies such as PulteGroup, Inc. (PHM Quick QuotePHM - Free Report) and KB Home (KBH Quick QuoteKBH - Free Report) . The company adjusts its approach based on current market conditions. This strategy allows Toll Brothers to respond effectively to changes in demand, especially in a fluctuating economic environment.

The company has been planning to maintain a 50/50 balance between BTO and spec sales. This approach will help the company meet diverse market needs. During the third-quarter fiscal 2024, Toll Brothers' spec homes represented about 54% of orders and 49% of deliveries. The company continues to aim for around 50% of its business to come from spec homes, driven by strong demand from buyers seeking quicker move-ins.

Significant Land Positions Enhances: Strategic land acquisition strategy has been a key factor in Toll Brothers’ growth. It has secured some of the most sought-after urban locations in the country, where land is scarce and approvals are not easy to obtain. It is using its strong liquidity position to secure the most sought-after urban locations in the country, like New York City Market, Northern New Jersey, Washington D.C. and Philadelphia.

Securing prime locations and expanding its land portfolio has positioned TOL for future growth. These acquisitions enhance its ability to offer desirable properties and provide a buffer against market fluctuations by ensuring a steady supply of future projects.

In third-quarter fiscal 2024, TOL spent $374.7 million on land to purchase approximately 2,100 lots each. At the end of the fiscal third quarter, it owned and controlled 72,700 lots. Excluding the 6,769 lots in its backlog, controlled land represents 55% of the total. This land position supports growth in the fiscal 2025 and beyond, allowing the company to remain selective and efficient when evaluating new land opportunities. Based on the land the company owns or controls, TOL anticipates 10% growth in community count by fiscal year-end 2024, targeting 410 operating communities. Its extensive geographic footprint and deep land position will allow it to expand its community count in the fiscal 2024 and beyond. This is attributable to the faster sales of existing communities than anticipated.

TOL's Efforts for Driving Shareholder Value: Toll Brothers demonstrated a strong commitment to boosting shareholders’ value. The company plans to drive shareholder value by returning cash to shareholders through regular share repurchases and dividend payments. During third-quarter fiscal 2024, the company repurchased approximately 2.1 million shares at an average price of $118.57 per share for $245.9 million, bringing total repurchases to $427.1 million in the first nine months of fiscal 2024. It also paid more than $70 million in dividends year to date.

The company expects to repurchase $600 million of common stock in the fiscal 2024. These moves highlight the company’s stable financial position and commitment to reward shareholders. On March 12, 2024, the company announced a 10% increase in its quarterly cash dividend, raising it to 23 cents per share (92 cents per share annually) from 21 cents (84 cents annually).

TOL's Estimate Movement & Valuation

Analysts are confident about the stock, as indicated by recent upward revisions in earnings estimates. In the past 60 days, forecasts for the fiscal 2024 and 2025 have increased to $14.50 (from $14.03) and $14.31 (from $13.83), respectively.

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Toll Brothers is trading at a discount relative to the industry it belongs to, as shown in the chart below. TOL’s forward 12-month price-to-earnings ratio stands at 10.00, lower than the industry’s ratio of 11.43 and the broader Construction sector’s ratio of 17.86. It is also trading at a discount compared with industry big shots like D.R. Horton, Inc. (DHI Quick QuoteDHI - Free Report) . Despite the stock’s outperformance, TOL’s current valuation is still considered undervalued. This might suggest that the market has not yet fully recognized or priced the company's potential growth prospects or earnings potential.

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Potential Risks for TOL Stock

Challenging Market Conditions for TOL: High borrowing costs are currently impacting home sales and builder sentiment, creating challenges for housing investments from an industry perspective. Affordability concerns, driven by high inflation and mortgage rates, are restricting the potential for sales growth.

The decreasing backlog of orders, a key indicator of future revenue, indicates that TOL may face ongoing revenue pressures in the coming quarters. At the fiscal third-quarter end, Toll Brothers had a backlog of 6,769 homes, representing a year-over-year decrease of 7%. Potential revenues from backlog declined 10% year over year to $7.07 billion. The average price of homes in the backlog was $1,044,000 compared with $1,079,500 a year ago.

Although the Federal Reserve has indicated that it may reduce the key interest rate, the timing and scale of the cuts remain uncertain. Without a noticeable and significant decline in interest rates, a major recovery in housing demand appears unlikely. This adds a layer of risk for investors considering an investment in TOL.

Toll Brothers’ Margin Pressures: Higher mortgage rates, rising costs of building materials, and labor shortages are pressuring TOL's margins. During the fiscal third quarter, the company’s adjusted home sales gross margin of 28.8%, contracted 50 basis points (bps) year over year. SG&A expenses, as a percentage of home sales revenues, expanded 40 bps year over year to 9%. Increasing wages and inflated land prices are expected to further impact margins in the upcoming quarters.

Buy, Sell, Hold — TOL Stock?

Toll Brothers has shown resilience despite higher interest rates, driven by continued demand for luxury homes. The company's affluent customer base is less affected by economic downturns. A limited housing supply, strategic land acquisitions and strong demand in key markets further support its position. However, concerns about demand variability, regional challenges and the impact of increased incentives and spec home strategies on margins persist.

Although the Federal Reserve is expected to lower interest rates in September, this is unlikely to have a significant immediate impact on the housing market or business operations. Current stakeholders are advised to maintain their position in this Zacks Rank #3 (Hold) stock. At the same time, potential new investors might consider waiting for more clarity on how Toll Brothers navigates these challenges before making investment decisions. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.