Toll Brothers, Inc. (TOL Quick QuoteTOL - Free Report) has faced investor disappointment after its fourth-quarter fiscal 2024 earnings release, with its shares declining more than 11% since then. The drop reflects concerns over volatile mortgage rates, affordability-driven market softness, and anticipated pressure on gross margins for fiscal 2025, which likely weighed on investor sentiment.

If we look into this luxury homebuilder’s recent quarterly results, its earnings and revenues surpassed the Zacks Consensus Estimate and increased on a year-over-year basis, respectively. Notably, quarterly performance was highlighted by the record home sales revenue and significant growth in contracts. TOL's adjusted gross margin was 27.9% in the fiscal fourth quarter, 40 basis points (bps) above guidance, with SG&A expenses at 8.3% of sales, 30 bps better than expected (read more: Toll Brothers Q4 Earnings & Revenues Beat With Strong Contract Growth).

What’s Hurting Toll Brothers’ Stock Performance?

The affordability issue is a pressing concern. As reflected in data from the National Association of Realtors (NAR), the median age of first-time homebuyers has reached a record high of 38 years, while the median age of all buyers is now 56 years. Additionally, first-time buyers comprised just 24% of the market over the past year, marking the lowest level over four decades. This shift has reduced demand from younger, less affluent buyers who are more sensitive to financial barriers.

Certain markets, such as Austin, San Antonio, Phoenix, and parts of Florida, experienced softness due to affordability concerns in the fiscal fourth. While overall demand remained strong, these pockets of weakness required closer attention.

Again, incentives have been a double-edged sword for Toll Brothers. While they played a key role in driving order growth and maintaining sales momentum, particularly in a challenging environment marked by rising mortgage rates and economic uncertainty, they also posed a drag on profitability and gross margins.

In the fourth quarter of fiscal 2024, Toll Brothers increased its incentives to an average of 6.7% of the average home sales price, up from a typical range of 5% to 6%. This adjustment was primarily targeted at moving finished speculative inventory, especially during heightened market volatility leading to the election and a sharp rise in mortgage rates. Although this strategy succeeded in boosting orders by 30%, the higher incentives pressured gross margins. For example, the company's adjusted gross margin was 27.9% in the fiscal fourth quarter (down 120 bps from a year ago), but management explicitly noted that the increased incentives on spec homes weighed on profitability.

Looking forward to fiscal 2025, the lingering effects of these incentives are expected to impact the fiscal first quarter’s adjusted gross margin, projected at 26.25%, representing a low point for the year.

Can the Toll Brothers Stock Stage a Comeback?

Toll Brothers presents a compelling long-term investment case despite prevailing affordability challenges in the housing market. Demographics are a key driver for the company, with millennials entering the market later in life when they have higher incomes and more accumulated wealth, and baby boomers seeking new homes as they move into retirement. These trends, coupled with limited resale inventory and aging housing stock, bolster the demand for Toll Brothers' new homes.

Toll Brothers mitigates affordability concerns by targeting a more affluent segment of the market. Notably, 28% of TOL buyers in the fiscal fourth quarter paid all cash, significantly reducing their exposure to rising interest rates. Among buyers who financed their homes, the average loan-to-value ratio was 69%, reflecting substantial equity contributions and financial stability. The low 2.5% cancelation rate (as a percentage of backlog) in the fiscal fourth quarter underscores strong buyer commitment.

The company’s balanced approach between build-to-order and speculative homes enabled it to increase its return on equity (ROE). Speculative homes accounted for faster sales and returns, which complemented the broader product mix.

Toll Brothers grew its community count by 10% to 408 communities by fiscal 2024-end, and broadened its offerings across price points and geographies. This diversification has been mitigating risks and driving growth. Community count is projected to grow by 8–10%, with the company targeting 440 to 450 active communities by the end of fiscal 2025. This expansion highlights Toll Brothers’ confidence in its ability to capitalize on strong housing demand and favorable demographic trends, particularly among affluent baby boomers and millennials.

TOL’s Share Price Performance: Still Outperforms Industry

The company stock has surged 34.6% so far this year, outperforming the Zacks Building Products - Home Builders industry’s 11.3% rise. During the same period, the sector has increased 23.5%, while the S&P 500 gained 28.6%.

Meanwhile, the stock is currently trading below its 50-day but above its 200-day moving averages. While it shows short-term weakness, the stock is still in a longer-term uptrend.

Toll Brothers' YTD Share Performance

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Rising Analyst Optimism for TOL

Earnings per share (EPS) estimates for TOL have been on an upward trend for fiscal 2025. Estimates for TOL’s fiscal 2025 EPS have moved up from $14.50 to $14.55 in the past seven days.

Find the latest EPS estimates and surprises on Zacks Earnings Calendar.

This revision momentum reflects analysts’ growing confidence in the company’s ability to deliver strong financial results despite challenges.

Toll Brothers’ Valuation: A Bargain in the Industry

TOL remains attractively valued. Its forward 12-month P/E ratio of 9.44 is below the industry average, making it a discounted play in the homebuilding sector. Presently, TOL holds a Value Score of B.

It is also trading at a discount compared with big industry players like D.R. Horton, Inc. (DHI Quick QuoteDHI - Free Report) , Lennar Corporation (LEN Quick QuoteLEN - Free Report) and NVR, inc. (NVR Quick QuoteNVR - Free Report) . DHI, LEN and NVR are trading with forward 12-month P/E multiples of 10.4, 9.68, and 16.62, respectively.
 

Image Source: Zacks Investment Research

 Considering the company’s trailing 12-month ROE of 19.6%, which exceeds the industry average, TOL stands out as an efficient and profitable operator in a competitive market.

Image Source: Zacks Investment Research

Price Target Suggests Potential Upside for TOL

The company's strong position is further emphasized by its attractive Average Brokerage Recommendation (ABR). Out of 18 recommendations that contribute to the current ABR, 11 analysts have rated the stock as a Strong Buy and one is a Buy. This results in an impressive ABR of 1.94 for the company. Wall Street’s average price target for the stock stands at $156.13 per share, indicating a potential 9.6% upside from the most recent closing price.

An Update on Latest Mortgage Rates

Mortgage rates declined for the third week in a row, reflecting expectations of a potential Federal Reserve rate cut. Freddie Mac reported the average 30-year mortgage rate fell to 6.6% in the week that ended on Dec. 12 from 6.69% in the prior week, while the 15-year rate dropped to 5.84% from 5.96%. Chief Economist Sam Khater noted that lower rates, steady income growth, and a strong stock market have boosted homebuyer demand.

How to Play Toll Brothers Stock?

By leveraging its focus on financially stable buyers, the appeal of new construction, and strong retention metrics, Toll Brothers effectively navigates affordability challenges while capturing market share in resilient segments. These insights reinforce the company’s robust positioning in a challenging market.

Toll Brothers is projecting strong cash flow from operations in fiscal 2025, consistent with the $1 billion generated in fiscal 2024. This cash flow is expected to support key initiatives, including share repurchases and land investments.

Toll Brothers has demonstrated strong performance, driven by its strategic focus on affluent buyers, operational efficiency, and a diversified portfolio. Challenges such as regional softness and mortgage rates are mitigated by its ability to adapt through incentives and pricing strategies. The fiscal 2025 outlook reflects cautious optimism, with expectations of steady growth and margin recovery. This mix of resilience and adaptability positions the company well for the coming year.

Stakeholders should hold this Zacks Rank #3 (Hold) stock, while new investors may wait for more clarity on Toll Brothers' handling of mortgage rate fluctuations and macroeconomic challenges. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.