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Invest in hammers, nails and mortgages
Real estate in your portfolio is a no-brainer, but finding the right real estate stocks can be tricky. Here are 7 screens to get you started.
By Harry Domash
Should you invest in real estate? The answer to that question should be a no-brainer.
Unless you really have been living in that legendary cave, you know that real estate values go up over time . . . if for no other reason than your parents or other old-timers probably have bored you with stories about how they could have bought such and such for a pittance 25 years ago.
Why is real estate a sure bet? Like most things, real estate follows the law of supply and demand. But theres a catch! Even though the demand (population) steadily increases, the supply doesnt change. There isnt ever going to be any more land!
Thats a pretty compelling reason to invest in real estate. But buying real estate is easier said than done. With prices already sky-high, coming up with the required down payment, not to mention the monthly payments, isnt doable for many.
The good news is that you can invest in real estate without actually buying any property. One popular method is buying real estate investment trusts (REITs). (Heres a link to a story telling you how.)
Another approach is to simply buy stocks of companies active in the real-estate sector. Like REITs, these companies tend to do well when the real estate market is strong. Residential home builders are the obvious choice, but there are also other ways to participate. Heres a rundown on the best sectors, along with stock screens that you can use to come up with worthwhile candidates.
Residential home builders
Conventional wisdom considers residential home building the quintessential cyclical industry, susceptible to the slightest moves in interest rates and employment figures. That was true in times past, but changes in market conditions have gone a long way to smooth out the traditional home-building industrys ups and downs.
One need only look back to the 2000-2002 recession and stock-market meltdown for evidence. Despite the bad times, falling interest rates countered the effects of lower employment and home sales, along with home builders share prices, soared. For instance, leading homebuilder Lennars (LEN, news, msgs) stock price more than tripled from January 2000 through December 2002, in stark contrast to the S&P 500s ($INX) nauseating 40% drop.
Why have homebuilding stocks become less cyclical? Look in your own neighborhood. If its like mine, anyone contemplating building a meaningful number of new homes faces tough going. The cumulative effect of widespread opposition to new development has permanently changed the supply/demand equation. Barring severe economic downturns, experts predict that demand will exceed supply for the foreseeable future. Further, residential home builders increasing sophistication smoothes out a lot of the earnings volatility. The major players avoid getting stuck with unsold inventory by keeping close tabs on customer needs and pre-selling much of their inventory before beginning construction.
In terms of investing in home-building stocks, the largest companies have the advantage. Most have huge inventories of vacant land that they are nursing through the development-approval process. Over time, all this land increases in value even if its not developed. Also, because of economies of scale, the largest builders are also the lowest-cost producers.
Heres a screen for turning up some worthwhile home-building candidates. It looks for companies in the residential-construction industry with revenues of at least $1 billion over the past 12 months. Of course, sales dont mean much if they dont produce profits, so the screen requires a minimum 15% return on equity, which is a basic profitability measure.
To weed out companies that are currently successful but running short of buildable land or facing other long-term problems, the screen also requires a minimum 5% consensus average annual earnings-growth forecast for the next five years. This requirement also will keep you out of the home-building sector altogether if the economy looks so bleak that no stocks pass the test.
Title-insurance companies
Because all mortgage lenders require title insurance when you buy a home, increasing home sales tend to lift title insurers profits. However, mortgage refinancing also requires title insurance, and profits from that activity can add mightily to results.
Unlike home sales, refinancing volumes are very interest-rate-sensitive. Many homeowners refinanced more than once when interest rates dropped in response to the 2000-2002 economic slowdown, driving title-insurance earnings to record highs. But nobody wants to increase their mortgage payments unless they absolutely have to, so refinancing levels shrink drastically in a rising-interest-rate environment.
Consequently, title-insurance stocks are best bought when interest rates are headed down and avoided when they are expected to rise. Which way are mortgage rates heading? Nobody knows for sure, of course, but interest rates usually rise when the economy strengthens, and drop in a weakening economy.
The Financial Forecast Center is in the business of forecasting interest rates. You can see its six-month take on the direction of mortgage interest rates for free on its site (see link at left under Related Sites), but youll have to pay if you want to see a longer forecast. If you want to see how current rates fit into the long-term picture, check out the Federal Reserve chart listing monthly rates going back to 1971 (see link at left).
That said, here's a screen that digs up stocks in the surety and title-insurance industries. It looks for substantial companies ($1 billion market capitalization) with positive earnings over the past 12 months and a debt-to-equity ratio below the industry average to eliminate non-profitable or debt-heavy candidates. The screen also requires flat or positive next fiscal year earnings growth to keep you out when the outlook is adverse.
MSN Money's Deluxe Screeners category for the surety & title-insurance industry includes some companies that are not primarily title insurers. You can check on each company's main business by clicking on the ticker symbol in the screen results and then looking at the Company Report, which includes a business description.
To save you the trouble of looking them up, here are some of the major companies that garner a significant portion of their business from title insurance:
Capital Title Group (CTGI, news, msgs)
First American (FAF, news, msgs)
Fidelity National Financial (FNF, news, msgs)
Investors Title (ITIC, news, msgs)
LandAmerica Financial Group (LFG, news, msgs)
Old Republic International (ORI, news, msgs)
Radian Group (RDN, news, msgs)
Stewart Information Services (STC, news, msgs)
Cyclical real-estate industries
Many real-estate-related industries, such as building-materials suppliers, are cyclical in nature. That is, they are slow growers whose fortunes depend as much or more on the economic cycle than they do on management actions. Stocks in these industries tend to trade in a range making it difficult to make money when you follow a buy-and-hold strategy.
However, there is profit potential if you buy them when their outlook begins to recover from a cyclical slowdown, but the market hasnt yet realized that things are picking up.
Here is a rundown on some of these industries, along with screens for stocks in each that are trading well below their cyclical highs and show signs of turning around. In general, these turnaround screens search for stocks that are trading closer to their recent lows than their recent highs; the filters also require strong company fundamentals with regard to debt, sales growth and other key factors. (The concept for the turnaround stock screen is described in my column, "Spot the comeback stocks of tomorrow.")
Depending on recent market action, some of these screens may show no investment candidates at all. Thats usually because the market sector has been surging, and there are no bargain prices to be had. But by loosening the parameters just a bit, especially in terms of price patterns and return on equity, alternative screens -- well call them Plan B screens -- usually do show results. Along with the more-stringent turnaround screens below, weve also offered Plan B screens.
All of the industries described below tend to move in tandem with home builders.- Cements and concrete: These companies sell aggregates, cement and other concrete products. You cant FedEx concrete, so companies in this sector usually have a lock on business in their geographic region. Besides being used for housing, increased highway construction also boosts profits in this sector. (Click here for the Plan B screen.)
- Home-improvement stores: While home-improvement retailers aren't really real-estate stocks, they certainly are tied closely with the industry. Home sales are the primary driver of home-improvement store sales. But retailers also see sales gains when homeowners are more inclined to fix up their existing properties instead of buying new homes. (Click here for the Plan B screen.)
- Wholesale building materials: Companies in this sector distribute of all kinds of building materials to retail home-improvement stores and builders. As such, their results tend to move in sync with home sales and remodeling activity. (Click here for the Plan B screen.)
- General building materials: These are the companies that make the plumbing, doors, roofing materials, etc., which wholesale distributors sell. (Click here for the Plan B screen.)
- Lumber, wood production: This sector includes traditional lumber companies, plus makers of wood products such as kitchen cabinets, doors, etc. Sector sales are driven by new home sales and remodeling activity. (Click here for the Plan B screen.)
To cast your net more broadly, you may want to check out other real estate-related sectors such as furniture and appliance makers. I've omitted them here, though, because stocks in these sectors tend to respond to competitive pressures and do not necessarily move as a group.
Ive also omitted reference to mortgage-investment companies. Profits in this sector hinge on arcane factors such as the spread of the yield curve and the effectiveness of each companys interest rate hedging activities.
As always, consider these screens and these stocks a starting point for continuing research. The more research you do, the better your results.
At the time of publication, Harry Domash did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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