Last year was a miserable one for the stocks of homebuilders and other stocks with exposure to new housing construction, as spiking mortgage rates and fears of an economic slowdown crimped demand for housing while inflation caused building material prices to soar. The SPDR S&P Homebuilders ETF (NYSEARCA:XHB) lost 28.9% for the year, while the iShares U.S. Home Construction ETF (BATS:ITB) shed 26.3% of its value.
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But in 2023, it’s a different tune for homebuilders and the rest of the industry — XHB is up 30.3% year-to-date, while ITB is up 38.3%. With the sector rebounding, it’s a good time to ask — which of these two homebuilder ETFs is best in class?
Why are These ETFs Soaring?
Sentiment towards housing and home builders was so bad last year that some reversion to the mean was to be expected, and that’s exactly what we are getting this year.
Furthermore, based on this poor sentiment, these stocks became exceedingly cheap, with many top home builders trading at single-digit price-to-earnings multiples. Even now, after their strong rallies year-to-date, XHB and ITB have average trailing-12-month P/E ratios of 11.9 and 9.4 times earnings, respectively. Both of these valuations are very attractive in comparison to the S&P 500’s (SPX) average P/E multiple of about 20.
Meanwhile, some of the challenges that dogged the industry last year, like surging inflation and supply-chain constraints, are beginning to ease. Furthermore, data from the U.S. Census Bureau showed that new housing starts surged 21.7% month-over-month in May, indicating that demand from buyers could be heating up again.
Comparing Their Portfolios
XHB, which invests in the S&P Homebuilders Select Industry Index, holds just 37 positions, but its top 10 holdings account for just 38.6% of the fund, making this a fairly well-balanced ETF. Check out the table below from TipRanks’ holdings tool for a look at XHB’s top 10 holdings.
Meanwhile, ITB, which invests in an index composed of U.S. equities in the home construction sector, the Dow Jones U.S. Select Home Construction Index, owns more stocks than XHB, with 50 holdings, but it is more concentrated in its largest positions as its top 10 holdings account for nearly two-thirds of the fund. Check out the table below for an overview of ITB’s top holdings.
As you can see, there is plenty of overlap between XHB and ITB — both ETFs count Lennar (NYSE:LEN), D.R. Horton Inc. (NYSE:DHI), Pultegroup (NYSE:PHM), Builders Firstsource (NYSE:BLDR), NVR Inc. (NYSE:NVR), and Lowe’s (NYSE:LOW) among their top 10 positions, albeit at different weightings.
A look through the ETFs’ holdings shows another commonality. They aren’t limited to investing strictly in companies that build homes, they also invest in suppliers to the industry like Builders Firstsource, Owens Corning (NYSE:OC) and Eagle Materials (NYSE:EXP), and even home improvement retailers like Lowe’s, and Floor & Decor Holdings (NYSE:FND).
One key difference is that XHB counts investments in major HVAC companies like Carrier Global (NYSE:CARR) and Trane Technologies (NYSE:TT) among its largest positions, whereas ITB eschews these types of stocks.
As you can see, there are some differences in approach, but overall, these ETFs have a similar style of holdings. Their top holdings also collectively enjoy some pretty strong Smart Scores — six out of XHB’s top 10 holdings and seven out of ITB’s top 10 have Smart Scores of 8 or better.
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.
Both ETFs also feature identical Smart Scores of 8, indicating an Outperform rating.
Are XHB and ITB Buys, 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. Nevertheless, at $80.10, the average XHB stock price target implies only 0.4% upside potential.
Meanwhile, ITB has a Moderate Buy consensus rating, as 53% of analyst ratings are Buys, 39.7% are Holds, and 7.3% are Sells. At $86.24, the average ITB stock price target implies 1.8% upside potential.
Strong Performance Track Records Over the Long Term
Housing has a reputation for being a cyclical industry, but both of these ETFs have put up surprisingly good total returns over the past decade. While there has been plenty of volatility along the way, overall, when you zoom out and smooth out the results and look at returns over an annualized basis, they have treated their investors well.
Over a three-year timeframe, you could be forgiven for thinking that the returns of these ETFs are those of a tech or growth ETF. As of the end of May, XHB had a three-year annualized return of 18.8%. Over the past five years, it returned 13%, and over the past decade, it returned 9.2%.
As of the end of May, ITB had an even better three-year annualized return of 19.9%. Over the past five years, it returned 14.4%, and over the past 10 years, it returned 12.2%.
Both ETFs have posted solid returns for a long time, but ITB has outperformed XHB over all three time horizons.
Comparing Their Expenses
Both ETFs feature fairly middle-of-the-road expense ratios, with XHB’s expense ratio of 0.35% coming in a hair cheaper than ITB’s 0.39%.
How much of a difference could this make over time? In year one, assuming an investment of $10,000, an XHB investor would pay $35 in fees, while an ITB investor would pay $39 in fees. However, over 10 years, the gap grows. Assuming the fees remain constant and each ETF returns 5% a year, the XHB investor would pay $443 in fees while the ITB investor would pay $493. This is not a huge difference, but XHB is the more cost-effective option by a narrow margin.
Investor Takeaway
Wrapping things up, these both look like good ETFs. Their holdings trade at modest valuations compared to the overall market, they have strong Smart Scores, and they have delivered solid returns to investors over time despite the industry’s cyclicality.
They continue to look like good opportunities in the short term as challenges to the housing sector dissipate and solid long-term opportunities as more new homes will be needed for a long time.
XHB is a bit less top-heavy, and it is marginally more cost-effective while offering a slightly better dividend yield than ITB (XHB yields 0.9% while ITB yields 0.6%). Meanwhile, ITB has been a slightly better performer over the past three and five years, with a larger edge when zooming out to 10 years. As both ETFs look solid, which one is the better investment right now likely comes down to individual preferences based on the aforementioned factors.
