A sector that's raising the roof

For investors, there may be gold in nails, two-by-fours, and paperboard.

Not literally, of course.

But the US home-building industry is poised for a second strong year in a row, following an ebullient housing and home-building market in 2001.

"If employment comes back, along with a stronger economy, there could be a very healthy pace of new home building and sales in 2002," says John Lonski, chief economist at Moody's Investors Service, in New York.

Over the past few years, many investors battered in the stock market moved their money into real estate. In 2001, housing sales reached a record 5.25 million units, up some 2.7 percent from the prior year. New-home sales reached 906,000 units in 2001, another record.

Repeating last year's barnstorming gains seems unlikely. But strong housing starts from January and February of this year, in part attributed to unusually warm weather in many parts of the US, as well as to low mortgage rates, bode well for the industry.

"The one near-term danger," says Mr. Lonski, is that yields on US Treasury bonds might suddenly rise, which could push up mortgage rates. Thirty-year rates on home mortgages currently hover in the 6.5 percent to 7 percent range.

Still, most economists are upbeat as home values in many parts of the US continue to rise, reflecting a demand for new and existing homes.

That "wealth effect" allows existing homeowners to consider trading up to more expensive homes. In doing so, they create a larger market of vacant "starter" homes to enable first-time buyers to step through a new doorway of their choice.

"I'm cautiously bullish about the [housing/home construction] sector," says Mike Jaffe, who tracks the sector for Standard & Poor's Corp., in New York.

"Mortgage rates will probably go up a little, but as long as they are relatively accommodating, the home-building sector should do well this year, Mr. Jaffe says.

"The economy is not going to take off like a rocket," he adds, "so that will help keep mortgage rates down and home buyers busy."

Experts point out that ancillary industries, from lumber and paperboard companies to home-improvement suppliers, such as Home Depot and Lowe's, could ride the coattails of a continued building boom.

Lonski sees a strong possibility that furniture and appliance manufacturers, who actually lagged behind the overall housing sector last year, will catch up in 2002, as new-home owners – and people remodeling existing homes – will pry open their wallets to buy big-ticket items. As a result, mass-market home-goods retailers such as Sears could also benefit, Lonski says.

Still, says Lonski, selectivity is crucial, in part precisely because last year was so strong for many companies that they may be hard-pressed to repeat.

A safe way to get a broad handle on the sector: Buy into mutual funds that specialize, such as Fidelity Select Construction and Housing, which is up more than 20 percent for the past year.

Research firms such as Value Line and Morningstar can identify mutual funds that have significant positions in the sector.

For investors bent on buying individual stocks, examining the portfolio of these funds can also help identify firms that may benefit from an upbeat housing market. The list includes such companies as Whirlpool, American Standard, Black & Decker, D.R. Horton and Clayton Homes (both builders), Lowe's, Home Depot, and Caterpillar.

One other reason selectivity is now so important: consolidation. A study released last month by Andersen Corporate Finance LLC, a unit of accounting/consulting firm Arthur Andersen LLP, reckons that consolidation and mergers within the sector will intensify in the next few years.

In 2000, for example, the nation's top 100 home builders produced some 37 percent of all new homes. By 2011, the report says, the nation's 20 top builders will be constructing over 75 percent of all new home purchases.

So, say experts, when buying into housing-related companies, look for firms with solid sales, strong earnings flows, low debt, and established management. Look for companies, in other words, that are expected to be around for many years.