4 Building Trends with Solid Foundations

04/02/2012 12:00 am EST

Focus: STOCKS

Tyler Laundon

Editor, Cabot Small-Cap Confidential

There are some green shoots appearing in the residential construction industry, so it's a good time to find the top beneficiaries and start to ease into a stake, writes Tyler Laundon of Resource Prospector.

The key to making profitable investments is to narrow your focus down to the very essence of whatever trend you feel compelled to buy into.

Take housing for instance—there appears to be growing optimism regarding the state of the US housing market. But you can't just invest in "housing." That's a nebulous term for a market that has many facets, from commercial real estate to residential housing construction to mortgage-backed securities, to name just a few.

We have to pick a specific investment vehicle. The way I want to play a housing recovery is in construction-related stocks. Specifically, companies selling advanced materials that make a building more comfortable to live in and more efficient to build.

These types of companies represent the lowest-risk yet highest-reward candidates, in my eyes, because their products make sense for any sort of construction project—a new build, a fix and flip, a remodel, commercial, residential, high budget, low budget, and so on.

These materials are in demand because contractors want the building process to go efficiently, to keep costs under control, and to avoid headaches caused by inferior products.

There are more than a few examples of advanced materials—made by publicly traded companies—that fit the bill. Here are just a few that come to mind:

1. Spray Foam Insulation
Northerners love insulation because it shields us from those blustery winters. And southerners crave it because it keeps the air conditioning bill down. Over the last decade, advances in spray foam formulations have brought the cost down to a point where it's economical for most homeowners, whether for a remodel or new construction project.

Spray foam insulation is often so much better than the alternatives—fiberglass or blown-in cellulose—that its use from a performance perspective is a no-brainer. Labor costs can be similar, because it's efficient to spray in foam versus cutting and stuffing fiberglass. These days we also see spray foam insulation used in conjunction with traditional materials to match up the desired (or code-mandated) R-value with the homeowner's budget.

The net result is that while housing starts are way down, the pounds of methylene diphenyl isocyanate, or MDI (the chemical used in polyurethane spray foam), per housing unit is steadily climbing. The trend also suggests that a rebound in home construction could mean significant growth for the chemical companies that make these foams.

Uses for spray foam also include structural, sculpting, and flotation applications, so there is growth potential beyond housing.

2. Air Barriers and Roofing Underlayments
These are the rolls of materials that make a building look like a neatly wrapped present before actual siding and roofing materials go on. They come in various forms, but the purpose is essentially the same—keep water, ice, and wind out while allowing the house to breathe from the inside.

I can tell you from experience (I owned and operated my own contractor business for a decade) that good builders are neurotic about using the right materials for these applications—and that's a good thing, as any homeowner that's ever seen water pouring in through a sheetrock ceiling knows.

Companies that push the limits to make air barriers and underlayments perform better and easier to apply are doing well now. A stronger housing climate will likely mean more rapid growth.

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3. Paint
A fresh coat of paint has to give the most bang for the buck when homeowners want to improve their house. It's like a deep clean and a fresh look all at once—not to mention a necessary part of the process in new home construction.

One of the necessary ingredients in paint is titanium dioxide (TiO2), a white pigment that helps give paint opacity and better coverage. Generally speaking, the more TiO2, the higher the paint quality and the fewer coats required. Go into any paint store and you're likely to notice more paints touting better coverage—many are primer and paint in one.

I believe any sort of uptick in new home construction, fix-and-flips, and home improvement projects could lead to a dramatic increase in the amount of paint sold in the US. Like makers of spray foam, companies that manufacture TiO2 stand to benefit.

4. Fasteners
Have you ever purchased a box of those square-headed screws only to get home and have every single one strip out before it's all the way in the wood? Or seen every nail bleed through cedar clapboard siding? There are all sorts of fastener-related nightmare scenarios that play out every day because an inferior product was used.

The fastener is the most basic building material, but also one of the most important. And the number of options is going up exponentially as the variety of building materials increases. Companies that are on the leading-edge of fastener-related technology are also doing well now, and will only do better if more housing units get built.

The Bottom Line
There aren't many pure-play small cap stocks that we can buy to get exposure to the above construction materials. But there are a few mid-cap companies that I like, some of which pay modest dividends. Take a look at Fastenal (FAST) as a starting point.

I'll write a follow-up article on why I think the general housing market is improving, but for now suffice to say that I believe better times lay ahead. I prefer as focused an investment as possible to play the trend, and for me that means the makers of construction materials that we want in our homes, and which contractors won't do a job without.

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