PulteGroup, Inc. (NYSE:PHM) and D.R. Horton, Inc. (NYSE:DHI) are the two most active stocks in the Residential Construction industry based on today’s trading volumes. The market is clearly enthusiastic about both these stocks, but which is the better investment? To answer this, we will compare the two companies based on the strength of their growth, profitability, risk, returns, valuation, analyst recommendations, and insider trends.

**Growth**

The ability to grow earnings at a compound rate over time is a crucial determinant of investment value. Analysts expect PHM to grow earnings at a 20.39% annual rate over the next 5 years. Comparatively, DHI is expected to grow at a 12.44% annual rate. All else equal, PHM’s higher growth rate would imply a greater potential for capital appreciation.

**Profitability and Returns**

Just, if not more, important than the growth rate is the quality of that growth. Growth can actual be harmful to investors if it comes at the cost of weak profitability and low returns. To adjust for differences in capital structure we’ll use EBITDA margin and Return on Investment (ROI) as measures of profitability and return. PulteGroup, Inc. (PHM) has an EBITDA margin of 9.01%, compared to an EBITDA margin of 12.12% for D.R. Horton, Inc. (DHI). This suggests that DHI underlying business is more profitable. PHM’s ROI is 7.30% while DHI has a ROI of 8.80%. The interpretation is that DHI’s business generates a higher return on investment than PHM’s.

**Cash Flow **

If there’s one thing investors care more about than earnings, it’s cash flow. PHM’s free cash flow (“FCF”) per share for the trailing twelve months was +0.32. Comparatively, DHI’s free cash flow per share was -0.35. On a percent-of-sales basis, PHM’s free cash flow was 1.26% while DHI converted -1.08% of its revenues into cash flow. This means that, for a given level of sales, PHM is able to generate more free cash flow for investors.

**Liquidity and Financial Risk**

Liquidity and leverage ratios measure a company’s ability to meet short-term obligations and longer-term debts. PHM’s debt-to-equity ratio is 0.73 versus a D/E of 0.39 for DHI. PHM is therefore the more solvent of the two companies, and has lower financial risk.

**Valuation**

PHM trades at a forward P/E of 10.10, a P/B of 1.91, and a P/S of 1.00, compared to a forward P/E of 12.92, a P/B of 2.05, and a P/S of 1.09 for DHI. PHM is the cheaper of the two stocks on an earnings, book value and sales basis. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.

**Analyst Price Targets and Opinions**

Just because a stock is cheaper doesn’t mean there’s more value to be had. In order to assess value we need to compare the current price to where it’s likely to trade in the future. PHM is currently priced at a 2.64% to its one-year price target of $26.50. Comparatively, DHI is 4.29% relative to its price target of $38.95. This suggests that PHM is the better investment over the next year.

The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.60 for PHM and 2.10 for DHI, which implies that analysts are more bullish on the outlook for PHM.

**Risk and Volatility**

Beta is an important measure that gives investors a sense of the market risk associated with a particular stock. A beta above 1 signals above average market risk, while a beta below 1 implies below average volatility. PHM has a beta of 1.06 and DHI’s beta is 1.23. PHM’s shares are therefore the less volatile of the two stocks.

**Insider Activity and Investor Sentiment**

The analysis of insider buying and selling trends can be extended to the aggregate level. Short interest, which represents the percentage of a stock’s tradable shares currently being shorted, captures what the market as a whole feels about a stock. PHM has a short ratio of 4.35 compared to a short interest of 2.64 for DHI. This implies that the market is currently less bearish on the outlook for DHI.

**Summary**

PulteGroup, Inc. (NYSE:PHM) beats D.R. Horton, Inc. (NYSE:DHI) on a total of 8 of the 13 factors compared between the two stocks. PHM is growing fastly, has higher cash flow per share and has a higher cash conversion rate. In terms of valuation, PHM is the cheaper of the two stocks on an earnings, book value and sales basis, PHM is more undervalued relative to its price target. Finally, KBH has better sentiment signals based on short interest.