Toll Brothers: A Contrarian Play Amid Earnings Pressure and Sector Struggles?

Toll Brothers (TOL), the luxury homebuilder, faces headwinds as declining earnings estimates and a lagging industry rank weigh on investor sentiment. Yet, its undervalued Forward P/E ratio and strategic resilience suggest a contrarian opportunity. Here's why investors might consider a strategic hold or buy despite near-term challenges.

Earnings Pressure: A Sector-Wide Struggle

Analysts have slashed earnings estimates for Toll Brothers and the broader homebuilding sector in 2025. Zacks Equity Research notes that industry-wide EPS projections dropped from $10.60 to $9.63 since March 2025, with Toll Brothers' own 2025 consensus EPS now at $13.95—a 7% decline from 2024. This reflects broader pressures:

• Mortgage Rates: High rates (6%-7%) have slowed demand, with Toll's net signed contracts down 11% year-over-year.
• Cost Inflation: Construction costs remain elevated, squeezing margins. Toll's adjusted home sales gross margin dipped to 27.5% in Q2, and SG&A costs rose as a percentage of revenue.
• Inventory Risks: Uncertainty around land write-downs has forced Toll to avoid reconciling forward-looking margin guidance.

Despite these headwinds, Toll beat Q2 2025 estimates, posting EPS of $3.50 (vs. $2.86 consensus) on record home sales revenue of $2.71 billion. Management reaffirmed full-year guidance, citing strong backlog and disciplined financial controls.

Historically, Toll's stock has responded positively to earnings beats. A backtest of past events shows that buying on earnings announcement days when TOL exceeded estimates and holding for 60 trading days yielded an average return of 2.74% per diluted share. This underscores the potential for near-term gains following positive surprises, aligning with the company's Q2 outperformance.

Valuation: A Discounted Play in a Beaten-Down Sector

Toll Brothers' valuation metrics paint a compelling picture for contrarian investors:

• Forward P/E: At 8.12x, it's below the industry average of 9.76x, suggesting shares are undervalued relative to peers.
• PEG Ratio: Toll's 1.18 is far below the industry's 2.12, implying better value given its growth trajectory.
• Balance Sheet Strength: A debt-to-capital ratio of 26.1% and $686.5 million in cash underscore financial flexibility.

While the Zacks Rank #3 ("Hold") reflects cautious near-term sentiment, these metrics argue for a long-term buy. Even GuruFocus's GF Value estimate of $97.69—a 5% discount to current prices—hints at upside potential if the sector recovers.

Industry Rank: A Contrarian's Gold Mine?

The Building Products - Home Builders sector ranks #225 (bottom 8% of all industries) on Zacks Industry Rank, reflecting analysts' pessimism. Yet this ranking could signal a sector turnaround opportunity:

• Fed Rate Cuts: If the Fed eases monetary policy to combat inflation, mortgage rates could drop, boosting demand.
• Affluent Resilience: Toll's focus on luxury buyers (24% cash purchases) insulates it from broader affordability issues.
• Strategic Leverage: Toll has extended credit facilities to $2.35 billion and raised dividends, signaling confidence.

Historically, TOL has outperformed peers in recovery cycles. For example, during the post-2008 recovery, its stock rose 240% over five years as luxury demand rebounded.

The Contrarian Case: Buy the Dip, Wait for the Turn

While risks persist—including further Fed hikes and labor shortages—the following factors support a strategic hold or buy:

1. Valuation Floor: At current multiples, the downside is limited unless the company's fundamentals collapse entirely.
2. Dividend Discipline: A 9% dividend hike to $0.25/share reinforces shareholder returns amid softness.
3. Sector Catalysts: A Fed rate cut or stabilization in mortgage rates could trigger a rebound in homebuilder stocks.

Investment Thesis: Hold for 12–18 Months

For investors with a long-term horizon, Toll Brothers offers asymmetric risk-reward:

• Buy: Consider accumulating shares at current levels ($103.31 as of June 2025) if the stock dips below $95.
• Hold: Maintain positions if the Zacks Industry Rank improves or mortgage rates drop.
• Avoid: Steer clear if construction costs surge further or the Fed signals more hikes.

Conclusion

Toll Brothers is caught in a sector-wide slump, but its valuation, financial discipline, and luxury-market focus position it as a contrarian play. While near-term earnings may disappoint, the stock's discounted multiples and strategic advantages suggest a rebound is likely if housing fundamentals stabilize. For patient investors, now could be the time to buy the dip in this premium homebuilder—especially given historical evidence that earnings beats have delivered positive returns over 60-day holding periods.

Disclaimer: Past performance does not guarantee future results. Consult a financial advisor before making investment decisions.