June 14 (Bloomberg) -- The biggest slump in U.S. homebuilder stocks since 1994 has spurred investors with some of this decade's best records to snap up shares of Centex Corp., KB Home and Toll Brothers Inc. So far their confidence has been unrewarded.

Donald Hodges, whose Hodges Fund outperformed 99 percent of its peers the past five years, added to his stake in Centex as the shares tumbled 35 percent this year. Legg Mason Inc.'s Bill Miller and Hussman Strategic Growth Fund's John Hussman both bought KB Home amid the stock's 42 percent slide in 2006. Hussman also purchased Toll Brothers shares, down 26 percent.

The retreats have left the Standard & Poor's 500 Homebuilding Index trading at 4.6 times earnings, near the lowest since March 2000. That's too cheap to pass up because share prices may already reflect how much the housing slowdown will curb profits for the industry, said Hodges.

``I like the group, and the one that I continue to buy every day is Centex,'' said Hodges, whose $535 million, Dallas-based fund has returned an average of 15 percent annually in the past five years. ``It's a value, and the stock has overreacted to all of the talk of a real-estate bubble.''

The homebuilder index has fallen 34 percent this year on concern that the U.S. Federal Reserve will slow the housing market by extending its series of 16 interest-rate increases since June 2004. The drop would be the biggest since a 36 percent slump in 1994. The S&P 500 is down 2 percent.

Lower Value

Investors typically place a lower value on homebuilders' shares than on the market overall because of the perception that the industry's profit rises and falls with the economy and interest rates. The discount has widened this year.

The shares of Dallas-based Centex, for example, sell for 5 times earnings for the past 12 months, down from 11 in July and an average of 7.8 over the past five years. Companies in the S&P 500 sell for 16.4 times earnings.

Centex, whose shares posted average annual returns of 48 percent in the previous three years, in April slashed its fiscal 2007 profit forecast, citing slowing orders. The company is the fourth-biggest U.S. homebuilder by market value. Toll Brothers, the sixth-biggest, and Pulte Homes Inc., the second-largest, followed Centex with their own forecast cuts. D.R. Horton Inc. is the No. 1 homebuilder.

Hodges and Ronald Muhlenkamp of Muhlenkamp & Co. said housing bears may be overlooking the ability of the largest builders to withstand a slowdown, in part by taking business away from locally owned builders. The profit drop also looks worse than it is because many investors are using 2005, when new home sales reached a record 1.282 million, as a yardstick, they said. The National Association of Realtors predicts sales will drop 13 percent this year to 1.11 million.

`Dirt Cheap'

``We expect to see the public companies continue to get market share from the little guy,'' said Muhlenkamp, who holds Centex, Toll Brothers, and Pulte Homes in his $3.1 billion Muhlenkamp Fund, which has outperformed the S&P 500 every year this decade. Even if earnings drop by 20 percent and ``the stock is selling at 7 times earnings instead of 5 times earnings, we think that's dirt cheap for a good industry.''

Miller, the fund manager who has beaten the S&P 500 a record 15-straight years with his Legg Mason Value Trust Fund, last quarter added KB Home to the $5.97 billion Legg Mason Opportunity Trust Fund, according to regulatory filings. He also increased holdings in Centex and Lennar Corp. and maintained his stake in Pulte Homes. Miller didn't return calls.

Hussman's $2.7 billion Strategic Growth Fund, which has outperformed 98 percent of its peers in the past five years, also added stakes in Toll Brothers and KB Home this year. Hussman didn't return calls.

`Worse'

Some analysts have grown more pessimistic about how well housing sales will hold up. Wachovia Securities last week cut its ratings on D.R. Horton, Pulte Homes, Lennar and KB Home. The housing slowdown is ``worse than we thought,'' the firm said in a report. The National Association of Realtors also lowered its 2006 estimate for new and existing home sales, citing rising borrowing costs.

Interest rates may keep going up. Sandra Pianalto, president of the Federal Reserve Bank of Cleveland, this week became the seventh central bank official in as many days to warn that inflation was too high.

Even some investors who are bullish on housing stocks say they may fall further before rebounding. Wexford, Pennsylvania- based Muhlenkamp said he will add to his holdings once some of the ``selling pressure'' dissipates.

John Buckingham, whose Laguna Beach, California-based Al Frank Fund had 6 percent of its assets in homebuilders at the end of March, said stocks such as D.R. Horton were still a great value for investors who could stomach volatility.

``Certainly in the short run, it seems like the housing market is collapsing, but I think that is temporary,'' said Buckingham, who starting adding shares of D.R. Horton in 1999 to the fund, which has outperformed 93 percent of its peers in the past five years. ``It's a no-brainer to me, just as it was back in 1999.''

To contact the reporter on this story: Dune Lawrence in New York at dlawrence6@bloomberg.net; Daniel Hauck in New York at dhauck1@bloomberg.net.

Last Updated: June 14, 2006 00:05 EDT