BITS > MAY 2002

Continuing with Maslow -- Gimme Shelter?

Industry Insight

This series on industry group analysis, which began in last month's issue, emphasizes Stock Selection Guide characteristics. The intent is to profile industries and define the qualities of industry leaders and industry parameters from the perspective of NAIC investors.

Gimme shelter. We started this series last month with a focus on the food industry and now we'll proceed by continuing to focus on basic needs. It's generally a good idea to study peers and industry characteristics when conducting our stock studies. The new Online Premium Services (OPS) can provide outstanding support for this type of analysis. No matter what the source of the data is, it remains important to form judgments about relative growth rates and profit margins.

Surveying Sectors

The Standard & Poor's Compustat data distributes companies into 10 different sectors. The sectors are not balanced and there's clearly more companies in some versus others. Nearly all of the 1,700 Value Line companies have been categorized. Here's the distribution:

Sector - No. of Companies

The April 12, 2002 issue of Value Line is a smorgasbord of housing-related issues. Issue 6, which is released in mid-January, April, July and October could be thought of as one of Maslow's favorites.

The housing-related industries are generally part of the consumer discretionary sector. This sector, the largest with respect to the number of occupants, includes the following industries:

Some of you may want to join ranks with my wife and children about the "discretionary nature" of things like specialty stores and restaurants. They insist they're clearly staples and that Standard & Poor's has it all wrong. And Maslow probably leans towards things related to having a roof over one's head as something other than discretionary, but we'll stick with the categories as they are. I know it's a problem when cable TV isn't filed into something more essential. Try suggesting that control of the clicker is optional in our living room.

But I digress. We started with food last month, exploring the grocery industry (also known as food retail.) The premise is that nearly any portfolio would be prudent to have some core holdings in quality companies that provide "things we eat, things that keep our heads dry, and things we sit on with confidence that our heads will remain dry."

Industry Indicators

During our stock studies, we build expectations for growth, profitability and valuation. NAIC investors make comparisons of these characteristics among peers and form their own conclusions about the assumptions and judgments that we make.

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Figure 1: Homebuilders. Industry snapshot developed by Mark Robertson. Figures reflect his personal judgments as well as those of others. This sample of 13 homebuilders have been ranked by an estimate of company quality (highest-to-lowest) with averages calculated for key fundamentals. Current Price - April 12, 2002. TTM Sales - Trailing 12-month sales through the first quarter of 2002. Sales Growth - Calculated growth rate from 3-5 year forecast. Net Margin - Expected net margin, 3-5 year forecast. EPS Growth (ACE) - Analyst consensus estimate for long-term earnings per share growth rate. P/E Avg - Expected average price-earnings ratio, 3-5 year forecast. Financial Strength - Value Line rating from company report (ranges from C-to-A++). EPS Predictability - Value Line rating from company report (ranges from 0-to-100). Projected Average Return - Calculated from TTM sales, sales growth, expected net margin, expected outstanding shares and expected average P/E ratio. Includes average annual dividends. Quality - Calculated from relative sales growth, relative profitability, financial strength and EPS predictability (ranges from 0-to-100). Sources: Value Line Investment Survey, Quicken.com., and personal SSG studies done by Mark Robertson.

Compare the average expected sales growth rates, net margins, and average expected P/E ratios for the three accompanying industry groups: homebuilders (Figure 1), home furnishings (Figure 2) and home impovement (Figure 3). The retailers exhibit slightly higher growth but lower margins. Trends would suggest that, of the three, the retailers are more predictable when it comes to earnings.

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Figure 2: Home Furnishings. Recent Stock to Study (and Challenge Club holding) Leggett & Platt heads these eight companies from the home furnishings industry. The average expected sales growth rate is 8.6 percent and forecasted net margins are 6.4 percent for "things that we sit on." Current Price - April 12, 2002. Sources: Value Line Investment Survey, Quicken.com.

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Figure 3: Home Improvement Retail. The higher Financial Strength and EPS Predictability ratings among this industry group make it an interesting place to shop. Home Depot, ranked 5th in this year's BI Top 100, and Lowe's (ranked 32nd among the BI Top 100) have long caught the attention of NAIC investors. Current Price - April 12, 2002. Sources: Value Line Investment Survey, Quicken.com.

Industry Impressions

Finding Toll Brothers and D.R. Horton near the top of the homebuilders industry was no surprise. Both companies have been on NAIC investor radar screens for some time.

NVR, Inc. (NVR) was a bit of a surprise. The company markets single-family homes, townhomes and condominiums under three trade names: Ryan Homes, NVHomes and Fox Ridge Homes. With developments in 18 metropolitan markets and 12 states, the company has room for geographic expansion -- a key consideration as we build our sales growth rate forecasts. NVR's largest market is Maryland and accounts for 59 percent of revenues, another condition which could be vulnerable to a regional recession and should be considered during our studies.

As we study companies like NVR and Toll Brothers, we should attempt to understand how they achieve their relatively higher margins.

Interest rates have fallen and this favorably influences the outlook for homebuilders. Another driver has been a 30-year low in inventory for new homes. D.R. Horton, by focusing on first-time buyers, has and may continue to benefit from the demand driven by the children of baby boomers.

For those not building new homes, there's always the pride of ownership and that honey-do list. Those of us that are handyman-challenged have Tim "The Toolman" Taylor and Bob Vila to thank for those frequent opportunities to embarrass ourselves. Thankfully, my wife no longer even allows me to think about plumbing projects.

For those that thrive on these projects, and there's scores of folks who do, Home Depot and Lowe's came on the scene a few years ago and have shown no signs of slowing.

Retail delivers a special challenge for stock studies. Most NAIC investors study the characteristics of saturation. Value Line gives us a boost by providing "Number of Stores" (historical and projected) that allows us to monitor this aspect of growth. When the new stores aren't being built, and stores are forced to rely on same-store-sales, the outlook will generally change. Check this critical driver any time you're shopping among the retailers.

The rate at which we buy "things we sit on" is heavily dependent on unemployment levels, interest rates and other economic indicators. Demand moves with interest rates, the housing market and economic expectations that we all have. Furniture sales are influenced by consumer confidence levels and seasonal purchasing habits.

Furniture cyclicality takes shape in the form of the industry EPS Predictability rating of 61, as compared to home improvement retail (77) and even homebuilding (64).

Industry Insiders

William Pulte is chairman and founder of Pulte Home, one of the world's largest homebuilders. Pulte has grown during the past decade, in part through acquisitions. Even more remarkable, Pulte has kept his namesake company profitable since its founding in the 1950s. What expectations will you build for the companies that provide and furnish our dwellings?

Gimme shelter. But give it to me with good quality at a reasonable price. We carefully inspect our homes and attempt to pay a good price. Do the same with your portfolio holdings. Housing-related issues deliver a number of opportunities to build the core of our portfolios. Let's take full advantage of them.

Mark Robertson is director of online resources and senior contributing editor for BetterInvesting. He serves as a member of BetterInvesting Magazine's Editorial Advisory & Securities Review Committee. Mark can be reached at Robertson_Mark@comcast.net.