Three High Quality Plays for a Housing Recovery

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Wherever you look, real estate indicators are pointing in the same direction: up. This doesn´t mean that the recovery will be necessarily easy and smooth; nothing goes up – or down – in a straight line. But the fact remains that the real estate recovery is still young, and it will provide many opportunities for investors to profit from it over the next several years.

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Being on the right side of economic trends can be very helpful when it comes to investing, especially if it´s done via high quality companies with attractive fundamentals on a corporate level. Here's three high quality stocks benefitting from a housing recovery.

A High-End Homebuilder

Among the homebuilders, Toll Brothers (NYSE: TOL) is one of the best positioned for a long term recovery. The company targets a wealthy clientele, which means several important advantages in the first stages of an up cycle: better credit scores, lower unemployment in comparison to national averages and a preference for new homes over existing ones.

Higher average prices for its homes can create better margins for Toll Brothers when market conditions allow for it. Besides, its customer base is more prone to owning more than one home, and in a scenario of rising home prices a second home becomes more attractive from an investment point of view.

The company usually procures land a few years before actual construction in order to secure prime locations for its customers. This can be a serious problem in a bearish real estate market, as its exposes the company to falling land prices. But once things turn around, operating more like a property developer as opposed to just a builder can be a big plus for profitability.

Toll has streamlined its operations and cleaned its balance sheet over the last years, and dismal conditions in the real estate market have allowed its distressed investment arm Gibraltar to acquire land at bargain prices. As conditions improve, Toll should be able to benefit from those acquisitions in a material way.

Digging for Profits

Caterpillar (NYSE: CAT) owns an undisputed leadership position in the US construction machinery industry, which is supported by its strong brand recognition, quality reputation and extensive distribution network. If construction is on a recovery path, Caterpillar should certainly benefit from that trend.

But this is not a pure play on US construction; Caterpillar has been expanding into different geographies, especially emerging markets, in its search for growth over the last years. The acquisition of Bucyrus also means a considerable exposure to commodities and mining, which is a highly cyclical business.

Caterpillar has some serious cyclical risks, but that´s not necessarily a bad thing for investors. Lackluster global economic growth is already reflected in a conservative valuation for the stock, which trades at a P/E ratio of only 11.3 times earnings. In fact, the Chinese economy has been surprising to the upside lately, and this could mean some really good news for investors in this global powerhouse that is Caterpillar.

A Well Managed Bank

One thing that sets Wells Fargo (NYSE: WFC) apart from its competitors is its high quality management team and superior risk management policies. This means that the bank avoided the excessive risk taking and complex financial deals that took competitors like Bank of America (NYSE: BAC) and Citigroup (NYSE: C) to a situation of insolvency during the credit bubble and the collapse which came after it.

Better risk management also means more growth for Wells Fargo, while Bank of America and Citigroup are still trying to streamline their balance sheets and fully recover from the crisis, the company has been taking advantage of the opportunity to grow and gain market share from its peers.

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The bank has positioned itself as the largest home lender in the country, which is a fantastic asset when it comes to capitalizing the real estate recovery from the financial side. A strong balance sheet and access to lower cost financing make Wells Fargo the best alternative in the financial sector when it comes to benefitting from a housing recovery.

Bottom Line

The housing recovery is real and still young, so it will provide big opportunities for investors to profit from it over the next years. Be it in homebuilders, machinery, or banks, there are many high quality alternatives to choose from in order to ride the long term recovery trend.

Andres Cardenal owns shares of Caterpillar and Bank of America. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc , and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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