How to Play the Housing Recovery

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

When I say soon I mean in the next few years, not tomorrow. I want to make that clear from the outset, because housing and construction are in a slump. I do not think that construction, either residential or commercial, will help lead the economy out of its slump. I think it will follow as an effect of the economy improving. It's not something I can prove, but it's a working assumption that errs on the safe side time-wise.

Preparing for a rebound in housing and construction first requires you to have a list to keep an eye on. I chose a few companies here, but upon writing it I think I will have to write multiple articles, because there are some lesser known companies I want to discuss. For now let's focus on some big ones.

Housing Market Recovery Starts with Bargains

Home Depot (NYSE: HD) is a company you can see is well run by the share price alone. I am exaggerating a little, but for the last five years the share price has risen steadily. Hashing out the numbers is something that can be done on the numerous financial websites out there. The reason I place the company here is because I think a rebound in construction will start with small-scale projects like renovations. Also, the housing market is depressed. Bargain hunters might also buy a fixer upper as a first house and negotiate with a contractor to fix it up on the cheap. I may be making a lot of assumptions, but I have seen a lot of this first hand. Family and associates have gone through the same process.

If you want certain changes from your cookie cutter house the developer offers a nice selection. If carpets are standard you might have the option of going for hardwood, or instead of white paint you can go with wallpapering. Not all changes are common, but they do exist. However, the price of these can be rather high. The alternative for hardwood would be to head to your nearest Lumber Liquidators (NYSE: LL) and get your own flooring. Then you can hire a contractor to install it. I have seen numerous examples in my own life of this happening, because if you have already spent a ton on a house you look to save on the upgrades. Home Depot is the go to place for everything almost. The selection of light bulbs is unparalleled. So even in a normal market Home Depot has its draw, because a lot of the stuff you get there cannot be found elsewhere.

When construction picks up it should see even more of a benefit. Even for developers it does not make sense to have everything delivered. Certain items would just be easier to grab from the local store. As more people move into houses regular maintenance will require a trip over to Home Depot as well. You might pay a plumber $150 bucks for a clogged drain or head over to Home Depot for some drain cleaner or a snake. The company was doing well during the real estate slump since 2008. I can't imagine it would not do well as things improve.

The gray cloud to this silver lining is that the market is already rabid behind Home Depot and Lumber Liquidators. Both companies command high multiples with PE ratios at 21.84 and 34.47 respectively. A PE of 21.84 is high for Home Depot which normally hovers in the 17-18 area. Home Depot might still surprise and a long case could be made, but I would probably write puts around $20 or $19 especially with fiscal cliff brinkmanship awaiting us.

Lumber Liquidators is even higher at 34.47, and it does not even have a dividend so you would be placing a bet on further capital appreciation. The market really seems to like Lumber Liquidators and rightly so, but there are limits. One year ago the PE was around 19, and the price has been on a tear ever since. I would strongly urge waiting, despite all the earnings beats for Lumber Liquidators. Sometimes you have to pass on good companies to play it safe.

Furniture Stocks on their own Merit as well as Housing Recovery

Bed Bath & Beyond (NASDAQ: BBBY) is an interesting store, and offers items you would be hard pressed to find elsewhere, though increasingly there are versions available at Wal-Mart. The company recently had a nice quarter that was in line with expectations. My main concern about the company is its desire to return value to shareholders by stock buybacks. As you know using company cash to buy company stock lowers the value of the company, but the stock does not fall because there are less shares out there. Each share represents an increasing portion of the company.

Share repurchase programs are only useful if the stock is extremely undervalued. While BBBY has a 13.55 PE, below Williams-Sonoma's (NYSE: WSM) 18.82, it is above Pier 1 imports' 12.78. The company is not undervalued enough for a share buyback to have a massive impact. I think a dividend would be better. At least Williams-Sonoma has around a 2% dividend yield with increasing revenues and earnings, but it sports an almost 1.5 PEG ratio. That means that any future growth is built into the price. Views differ on the efficacy of the PEG ratio, but I think I would wait till I knew more about the company. In the last earnings call it did mention that it was preparing for a housing recovery by expanding renovation offerings.

Final Thoughts

I think I would go with Bed Bath & Beyond if I had to pick one of these companies. Home Depot is something I would definitely write puts on, but BBBY is a tentative choice for going long. There is much more research to do, but I have seen both Bed Bath & Beyond and World Market stores get pretty crowded. While I dislike buybacks it says something that the company is in a position to enact them. Williams-Sonoma with its higher PE and higher PEG is unappealing to me.

TheArchivist has no positions in the stocks mentioned above. The Motley Fool owns shares of Lumber Liquidators. Motley Fool newsletter services recommend Bed Bath & Beyond, The Home Depot, Lumber Liquidators, and Williams-Sonoma. 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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