“Building a Housing Portfolio”

By Taylor Muckerman - August 6, 2012 | Tickers: MHK, SHW, TOL | 0 Comments

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The fact that the stock market goes through boom/bust cycles is nothing new.  Famous investors from AW Jones to George Soros have vehemently stated that realizing this is imperative to becoming a successful investor.  While catching the peak or the trough isn’t always the easiest thing to do, getting in early and in the right fashion after sentiment switches can prove very fruitful to your portfolio’s gains.

In the US, the housing market had been on a tremendous ride until the bubble finally burst in 2007 after foreclosures had been increasing at a rapid rate.  Since this time, home prices have been crumbling to the new lows reached in 2012.  Over the last two years however, residential housing construction has been making a quiet return to form.  While prices have been oscillating in a relatively tight bandwidth, new, private-home construction has been mounting a comeback.  There are several ways to play this from an investing perspective, as there are multiple stages involved in the home building process.   

 

(Data Source:  US Department of Commerce)

(Data Source: S&P/Case-Shiller Home Price Index)

Building Materials

Providers of building materials are the first to feel the affects of a construction boom.  These companies are often bellwethers because they receive the orders from construction companies and report these earnings prior to the rest of the home building industry.  Any uptick in the Revenue of the residents of this sub-sector could be a sign to get invested at this stage or move on to Residential Construction or Home Furnishings/Fixtures companies themselves.  One company in particular has a solid foundation in the Building Materials industry:

- Sherwin-Williams Company (NYSE: SHW)

Being a leader in the domestic paint market, Sherwin-Williams is primed to reap the benefits if the current trend in home starts continues.  Across the US, Sherwin-Williams has a network of company-owned stores that simply can’t be matched.  This branding and convenience has allowed them to maintain consistent cash flow generation, while at the same time continuing their capital spending habits.  Even through the economic downturn, their stock price reflected their success, realizing 3- and 5-year gains of 132.64% and 92.78% respectively.  

Residential Construction

Residential construction companies are a clear no-brainer when it comes to reaping the benefits of a rise in home building.  In this segment, it is important to look for companies that have lean operations and above-average margins that will enable them to weather any troubling times, e.g. the past few years.  One such industry leader caters to affluent clientele who continue to place a premium on real estate:

- Toll Brothers (NYSE: TOL)

Accommodating high-end consumers, Toll Brothers acts as a property developer and homebuilder.  The former side of their business has been especially beneficial over the last few years as they have been able to acquire a portfolio of properties at distressed prices.  Now, as residential constructions begins to pick up, TOL will be able to utilize these land assets at prices that have begun to rebound from their recently realized lows.  Relative to their competition, they are slightly overpriced, but they provide shareholders with front running margins and ROE.  Toll Brothers recently touched its 52-week high on July 23^rd and provides no reason why it can’t continue higher if home starts maintain their current trajectory. 

Home Furnishings & Fixtures

Once the orders have been placed and the structure of the house has been erected, it is time for the builder or homeowner to decide on the interior accoutrement.  There is a wide range of companies in this segment of the homebuilding process because there are so many choices to be made, from which type of flooring to use to what kind of appliances to outfit the kitchen with.  Flooring is a major element of any homebuilder’s creation.  There happens to be company that has all of the tools necessary to hammer out profits while the residential home industry continues to build out:

- Mohawk Industries, Inc. (NYSE: MHK)

With offerings that cover the gamut of flooring alternatives, Mohawk Industries can outfit a home with carpet, hardwood, laminate, natural stone or ceramic tile.  Over the past few years, they have been able to fend off structural deterioration while improving their financial health through debt reduction.  To that end, their Current Ratio (Current Assets – Current Liabilities) has gone from a pre-crisis 1.49 to 2.18 in 2011.  While erecting a safer Balance Sheet, management has also shown their confidence in Mohawk's future through company-record capital expenditures in 2011.    

As America's economy begins to gather steam and the housing market continues in its current direction, becoming a stakeholder at the beginning should be a priority.  While you might choose to invest with companies other than those listed here, the idea should remain the same:  Look at the players who logically benefit first and follow the profits downstream.

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