Yesterday's column sparked some interesting conversation around Chez Melvin last night. Most of my correspondents agreed with me that housing is probably overvalued by the stock market and is best avoided. Others dragged out the old argument of markets being predictive and said that the housing stocks were discounting a huge improvement in real estate six to 12 months from now.
I have never found markets predictive at all, and I just love popping holes in that tired argument. The stock market has correctly predicted 12 of the last three recoveries and 27 of the last four recessions. Sectors are even more imprecise as predictors of future economic activity, in my opinion.
One of my major investment theories is that long-term survival is a big part of the success equation. If you guard against the downside and maintain a margin of safety in your core portfolio, the upside will generally take care of itself. The flip side is that avoiding sectors where the downside risks present a possibility of a real and permanent loss of capital must be avoided in order to increase the long-term chances of success. There is no such thing as perfection, so securities that are priced for it must be avoided in order to increase the odds of survival.
Housing and housing-related stocks are priced for perfection and beyond, in my opinion. The real estate markets are better than they were, but they are still not good. The same can be said of the jobs market and the financial condition of the consumer. Yet many of the stocks related to housing and big-ticket items for homes are priced as if it's party time. Chasing them here can lead to a big financial hangover.
Beacon Roofing Supply (BECN) is a stock that I believe has perfection priced in and is best avoided. The company has seen a pickup in sales, as it sells primarily in the Northeast, and the storm damage from Hurricane Sandy is creating short-term demand for roofing products. This is clearly not a permanent pickup in business, and Beacon is clearly not worth the $200 million or so in market cap it has gained in the past quarter. The stock has risen fivefold since the 2009 lows and is now above the boom-time highs it hit in 2006. The shares trade at more than 6x tangible book value and 20x free cash flow. It is a good company, but the stock is simply too high at this level.
The furnishing stocks also seem to be ahead of themselves at this point. I had occasion to do a little shopping since we moved last year, and I have not been in a crowded furniture store in the past six months. We have not had to wait more than a day or two for delivery. The business is better than it was, but I would hesitate to use the word "robust." Consumers are not eager to run out and replace furniture right now, and it is going to be a while before they are that confident.
I loved Hooker Furniture (HOFT) a few years ago when the furniture industry was unloved and undervalued. The stock was yielding 6% and trading at about 60% of tangible book value at the time. The company was profitable even at the worst of the credit crisis, and it had very little debt on the books. There was a huge margin of safety in the stock at the time. Since then, the stock has more than doubled, even though revenue and earnings are well below the levels of 2008. A multiple of 29x earnings for a furniture company is just too high. Again, I like the company, but there is no margin of safety at the current quote, and the stock is best avoided by long-term investors.
Whirlpool (WHR) is the largest appliance manufacturer in the world, and it is almost impossible to not have one or more of its products in your home. This is another stock that has risen fivefold from the lows of 2009 in spite of revenue that is well below the levels it had at that time. The stock was a steal back then, but given the very weak global economic recovery we have today, the shares are richly valued. Most of Whirlpool's revenue comes from big-ticket items, and the spending is just not there to justify the price right now. Rising raw-material prices forced the company to raise prices in Latin America, and that could cause it to lose market share in what had been its highest-growth market.
There is no margin of safety in housing and housing-related stocks right now. I think believe will trail a rising market and lead a falling one. Investors are wise to avoid the sectors for now.