You've read in the newspapers and on the Motley Fool Australia website that the housing market is picking up. Sydney home prices are starting to sizzle and so you think that a housing related industry, like building materials, would be a smart way to go.
In general, that is good thinking by considering the supply and demand of what is necessary for a real housing market boom to take place. But which building materials stock should you follow?
It's a cyclical industry connected to the housing market, so first of all you want buy into one of the big players towards the beginning of a housing market upturn. That way, you can capitalise on most of the move upward.
Of the basic materials suppliers, I like Adelaide Brighton Ltd. (ASX: ABC) the most because although its specialty is a commodity, cement, it has the highest net profit margins and return on equity of the major building materials companies, 12.3% and 14.2% respectively. The others are mostly in the single digits, except for Fletcher Building Limited (ASX: FBU), which has a 9.6% ROE. It has low, manageable amounts of long-term debt, only 1.71 times its 2013 full-year net profits of $151 million.
It isn't the biggest company by market cap or revenues, but it hasn't made any big losses throughout the past 10 years and its total shareholder return over the past five years was an average annual 27.6%. Just this month its share price rose above a long-time high of about $3.80 and currently is at $4.33.
The company has a steady record of earnings even though the past four years' earnings have been roughly around $150 million – $155 million. That stability attracts me since when the housing market goes into full swing, I can look forward to earnings rising from that level. The value investor side of me is confident that even if I don't make incredible amounts of profit, I equally am assured that I probably won't see a loss if things go sideways.
Foolish takeaway
Inevitably, when the boom has bust, you need to look for a company with strong financials and the track record to know it can weather the bad years as best as possible without losses. All the major building materials companies have risen in share price around 20-30% over the past six months, but I still want to pick one that I feel comfortable with over the long-term, and that means low debt, no annual losses, solid margins and decent returns numbers.
