A Housing Recovery Will Boost These Stocks

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

A recovering housing market is the key trigger that will lift many blue chip stocks from their current valuations. Housing provides a solid basis for consumer borrowing, and thus consumer spending. Therefore, it is an absolutely essential element of a recovering economy.

Although nearly all industries are affected by the general level of house prices, few are more directly linked to the market than big box retailers that cater to the housing industry. Companies like Lowe's (NYSE: LOW) and Home Depot (NYSE: HD) will benefit enormously from an improvement in the market, and their stocks will follow.

Great Returns, While You Can Get Them

Lowe's, Home Depot, and Lumber Liquidators (NYSE: LL) each had over 20% returns on invested assets during the boom years in the housing market. Even Sears (NASDAQ: SHLD), the struggling retail giant, earned respectable returns on assets during the bubble.

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However, earnings plummeted when the bubble burst and the companies' ROIs have never fully recovered.

But there are many reasons why that may be about to change. For instance, Home Depot is revamping its supply chain to improve efficiencies. As the housing market recovers—an inevitability at this point -- Home Depot's efficiency boost will lead to higher-than-expected margins. In addition, the company has bought back a significant number of shares outstanding in recent years and has committed to paying an above-average dividend.

Lumber Liquidators is also a prime beneficiary of higher housing prices and new housing starts. The company has a large share of the hardwood flooring market and was able to gain market share during the financial crisis and subsequent recession. However, Home Depot and Lowe's are making a strong push into the flooring market and will prove to be formidable opponents due to their enormous size advantage.

Even Sears will recover with a better housing market. The storied retailer of home appliances and hardware was once a cash cow. However, free cash flow has turned negative in recent years, and a recovery in housing is desperately needed to return to cash flow positive. If it can achieve this, it will be able to invest more in its Canadian stores and continue repurchasing shares and paying down debt. If no recovery comes, it can still monetize its valuable brands, including Craftsman and Kenmore. However, declining sales, intense competition, and a deteriorating brand image in the U.S. could spell doom for Sears despite a recovery.

The most attractive big box retailer is Lowe's. Lowe's is investing heavily in its own brands, which will allow it to earn higher margins than Home Depot. The company has had an undying focus on improving the bottom line since the bubble burst, and those efforts will show through when the housing recovery gets underway. There is, however, limited opportunity for growth, which has investors worried about fierce competition with Home Depot. But at only 7.7x normalized pre-tax earnings, the stock looks like the best bet for a housing recovery.

Final Thoughts

A rising tide lifts all boats; nearly every company in the U.S. economy will benefit from a recovery in the housing market. However, Lowe's, Home Depot, Lumber Liquidators, and Sears will benefit disproportionately. For those interested in participating in a housing recovery, a closer look at these companies is merited.

titans8904 has no position in any stocks mentioned. The Motley Fool recommends Home Depot, Lowe's Companies, and Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators. 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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