Luxury builder to endure

The Baltimore Sun

I am concerned about the housing market and my shares of the homebuilder Toll Bros. Inc. What are the prospects?

- C.M., via the Internet

The nation's largest builder of luxury homes has the best position in a very bad industry situation. It is less affected by the subprime mortgage crisis than many other builders because its average home price is $670,000.

Affluent buyers often have more attractive credit profiles, so the economy and interest rates have less effect on them. The company also is positioned well to benefit from well-heeled baby boomers.

Yet the concern is that so-called jumbo loans exceeding $417,000 are becoming harder to obtain and that there is less overall liquidity in the mortgage market. Moody's Investors Service predicts Toll Bros. "could possibly end up fiscal 2007 in negative cash-flow territory."

Shares of Toll Bros. Inc. (TOL) are down 31 percent this year after last year's 7 percent decline. Profit in its fiscal third quarter, which ended July 31, plunged nearly 85 percent, and its home cancellation rate of 24 percent was its highest in 21 years.

No one can know how long the housing downturn will continue, with estimates ranging from several quarters to as long as two years or more.

This situation won't last forever, however, and when conditions do improve, Toll Bros. is likely to be in a strong financial position, with plenty of cash and borrowing capacity.

It has reduced its new-home production, is conservative in its purchase of land and usually doesn't start building until a contract is in place.

The consensus analyst rating on shares of Toll Brothers in this uncertain period is a "hold," according to Thomson Financial. That consists of two "buys," eight "holds" and one "sell."

Chief Executive Officer Robert I. Toll, who founded the firm with his brother Bruce more than 35 years ago, heads a senior management team that has worked together for more than 20 years. Some experts wonder about a long-term succession plan.

Earnings are expected to decline 83 percent for the just-ended fiscal year and rise 1 percent the next year. The five-year annualized return is expected to be 9 percent compared with 11 percent for the residential construction industry.

The results for Alger Capital Appreciation Fund look great. Is there any reason not to like it?

- V.L., via the Internet

It has been a dazzling performer since Patrick Kelly took over as portfolio manager in September 2004.

He has made the right calls at the right times, using his own research to determine the price targets for stocks. An example of an especially successful holding that boosted overall fund results is gun maker Smith & Wesson Holding Corp. Kelly also still believes Google Inc. has further price potential.

The concerns about this fund, beside the question of whether Kelly's hot hand will continue, are its above-average expenses and high portfolio turnover.

The $628 million Alger Capital Appreciation Fund "A" (ACAAX) is up 38 percent over the past 12 months and has a three-year annualized return of 27 percent. Both results rank in the top 2 percent of all large growth funds.

"The strategy is very aggressive, with the portfolio manager trading stocks frequently, so only the most aggressive investors can be comfortable with this fund," said Katherine Yang, analyst with Morningstar Inc. in Chicago. "While it has been doing very well, it is not a fund that we recommend because it has high trading costs and is less tax-efficient."

Kelly has been an analyst at Alger since 1999 and a vice president and senior analyst since 2001. This is his first time as a fund manager. He began his career as an investment banking analyst with SG Cowen.

His valuations are based on earnings expectations and discounted cash-flow models. He quickly unloads a stock as soon as it reaches his price target. That means his fund is best used in conjunction with less-volatile investments in an individual's portfolio.

One-fourth of the portfolio is in technology hardware, with other significant holdings in health care, financial services and industrial materials. Top holdings recently included ON Semiconductor Corp., Apple Inc., Weatherford International Ltd., Altria Group Inc., CME Group Inc., General Dynamics Corp., Hologic Inc., Cisco Systems Inc., Oshkosh Truck Corp. and Cummins Inc.

Alger Capital Appreciation has a "load" (initial sales charge) of 5.25 percent and a $1,000 minimum initial investment. Its annual expense ratio is 1.39 percent.

Why does the government change interest rates?

- S.N., via the Internet

The interest rate that the Federal Reserve sets influences the cost of money, which means the rates that lenders can charge borrowers. Specifically, its short-term federal funds rate is the interest rate on overnight loans between banks.

"The [federal] funds rate has a big impact on short-term rates like three-month Treasury bills, adjustable-rate mortgages and the prime interest rate that affects small businesses and home equity lines of credit," said Mark M. Zandi, chief economist with Moody's "It has less impact on long-term rates such as a 10-year Treasury or a fixed-rate mortgage."

When the Fed is concerned about inflation, it raises interest rates so that it costs more to borrow money. That makes it more difficult to spend and invest, so, in theory, the economy slows and inflation moderates.

If the economy is struggling, it lowers interest rates as it has done twice in the past two months.

Andrew Leckey writes for Tribune Media Services.

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