Time to Switch Houses?

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

There has been much chatter recently about the great recovery in housing that is about to take place.  Count me as one of the skeptics as I believe the data has been grossly overstated to support the bullish thesis.

Take for instance the recent new home sales release for the month of July, which showed seasonally adjusted new home sales eclipsing 372,000 at an annual rate.  This exceeded estimates of 365,000.  Coincidentally, the Federal Housing Finance Agency printed a release saying house prices are up 3% year-over-year.  The timing couldn’t have been better as the media ran with that story instead of the release by the Census Bureau.  They grabbed the good sales number from the Census Bureau and then the pricing data from the FHFA.  However, hidden in the Census Bureau release was the fact that the median price of a new home sale was $224,200, -2.1% from June and -2.5% from July 2011 when the median price was $229,900.  Huh?

Other hidden data like the surging sales of multi-family structures also has me leery.  Despite the fact that I don’t believe a boom is about to commence, I do believe that a bottom has been established.  I believe there will be mini surges and mini pullbacks over the next couple of years, but no new boom.  Maybe in the back-half of the decade we start a sustainable uptick in all thing housing.  This doesn’t mean that you have to have to avoid all housing related investments.  Some have surged in anticipation of the new boom, while others have gotten little attention.  I would favor investing in those that haven’t gotten the notoriety at the expense of those that are front and center.

Sell the retailer and buy the manufacturer

Home Depot (NYSE: HD) has certainly been front and center following a series of quarterly achievements, especially relative to its sagging competitor, Lowe’s Companies (NYSE: LOW)

The chart shows quarterly same store sales for the past three years for both HD and LOW

<img src="/media/images/user_36/hdsss_large.png" />

Home Depot stock has surged 70% over the past year, partly on performance on partly on what used to an above-average dividend yield.  Well, the yield has gone from above 3% to 2.05%.  The price-to-earnings ratio has surged to 20x, which is bumping up against a five-year high and is a notable premium to the S&P 500.  The company has done an admirable job turning operations around with return on invested capital moving form 9% in 2008 to 14% in 2011.  While, it may be a great company, I would cash in on the initial turnaround, as comps will become increasing difficult to surpass.  Investors may want to move out of HD and into a leading provider of power and hand tools.

Stanley Black & Decker (NYSE: SWK) is a leading provider of power and hand tools as well as other industrial and security applications.  The company generates more than $11 billion in annual sales and has a dividend yield that exceeds Home Depot at 2.9%.  Key brands include Black & Decker, Stanley, DeWalt, Baldwin, and a host of other popular professional brands. 

The company expects to grow organic sales 4-6% with pricing moving the top-line up 10% annually.  EPS is expected to match or slightly exceed sales growth over the next five years.  These expectations actually mildly exceed what is expected of Home Depot.  Yet the stock trades at just 12x earnings, a 40% discount to Home Depot.  The one real edge Home Depot has on Stanley Black & Decker is the fact that Home Depot generates all their sales in the United States.  Yes, this is a good thing with the U.S. poised to be a relative winner as Europe struggles.  SWK generates 30% of sales in Europe, which is clearly a sore spot that will persist for many years.  Even so, the valuation discount is just too great given reasonably similar growth outlooks and strong dependence on housing strength.  Investors should consider swapping out of Home Depot and into Stanley Black & Decker.

Sell homebuilders and buy housing components

Toll Brothers (NYSE: TOL) was the latest to report a winning quarter amongst the homebuilders.  Hey, they are making money now!  After hemorrhaging cash from 2008-2010, the company made a couple pennies per share in 2011 and EPS will likely jump by a factor of 2 or 3 times here in 2012.  They will continue to be profitable going forward, but the consensus expectations will only be met in a boom scenario.  The 120% advance in the stock price doesn’t necessarily mean sell, but when consensus is looking for EPS to go from $0.24 in FY11 to $1.45 in FY14, a boom scenario is the only way that becomes possible.

Investors may want to look under the mattress for a company with some beaten down expectations instead of jumping on a crowded trade and hoping a company beats already elevated expectations.  Tempur-Pedic International (NYSE: TPX) is one example.  Following a string of weak quarters, the leading mattress manufacturer’s stock has plummeted 62% from its April high.  So much for a pillow-soft landing as the marketplace competition heats up.  It may take some time to turnaround results, but expectations and the stock have been reset to the point where just getting any positive lift in North American sales could send the shares moving up.  I still see value in the stock at 10x earnings and an attractive free cash flow yield that is supported by minimal capital expenses. 

Bottom Line

Investors should tread cautiously when reading about the new housing boom and be sure to dig into the details.  With the outlook still a bit murky, it makes sense to own names that have low expectations and a cheap valuation- names like SWK and TPX.  There are others out there for sure, but a whole lot less than the ones that have already gone parabolic in anticipation of the next housing boom.

market8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Tempur-Pedic International. Motley Fool newsletter services recommend The Home Depot. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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