RealMoney Silver - Wolseley Has a Strong Foundation

Wolseley Has a Strong Foundation
By John Reese
RealMoney.com Contributor
10/3/2007 5:59 AM EDT

When things are good for the market, even the dregs go up. And when things are bad, well, companies with solid prospects suffer. Blame it on market psychology, the natural order of things, or whatever.

The point is, with seemingly all real estate and construction stocks struggling -- no matter how good they are -- now is the time to start stocking up on the winners among these stocks. Sure, the real estate market is bad and will not turn around anytime soon. But it will turn around eventually.

Now is a good time to buy into the long-term winners. They may not seem like good buys now, but they will likely show themselves in the future to have been today's bargains. Wolseley (WOS) is just such a company.

A Building Materials Supplier on the Cheap

There's a saying in the investment world -- "a rising tide raises all ships" -- meaning when the market goes up, just about all stocks are affected and find their prices going up, even the dregs of the market.

Less talked about is the converse, namely that a falling tide lowers all ships. We are seeing this phenomenon happening now with the real estate sector. Just about all companies with exposure to real estate, such as home builders and banks, are finding themselves out of favor. A mere whiff of a company having a connection to real estate or construction is enough to put its stock in the doghouse.

This is bad for such stocks, but not necessarily bad for stock market investors. Sure, many of these companies are struggling at the moment and some may be seriously wounded for a long time. But if you look beyond the short term and find solid stocks that today are battered down unfairly, chances are good they are excellent values. When the real estate market turns around -- and it will -- these companies are well positioned to take advantage of the uptick and leave their competitors behind.

To take such a chance requires a degree of risk-taking and contrarian thinking that not all investors are comfortable with. Are you willing to go today where most investors are afraid to venture? If so, I have a company for you.

British-based Wolseley, which trades on the New York Stock Exchange, has 79,000 employees and operates in 28 countries. This building-materials supplier is very large in Europe and has sizable operations here in the U.S.; its annual sales are about $28 billion.

In the last three months, Wolseley's stock has gotten a haircut of about 30%, with 20% of that coming in the last month. Its most recent financials did not make many people happy. If you buy the stock now, you will be getting in near the bottom of its 52-week trading range.

After the company released its earnings report, Forbes.com reported something interesting: Wolseley became "a top stock pick for analysts." It seems that professional observers are believers. Admittedly, the company is viewed by some as "the best of the bunch," and the bunch is not all that inspiring. But I think this is a good time to load up on Wolseley stock.

Its price is low and the company is on the outs with investors, but the company is the major player in its market, its stock is down and the company is well run. This is not a stock you will flip in a couple of months and make big money. Rather, it will likely feint-and-jab for a while, but will eventually pound its way back into shape and capitalize on its advantages. When the bell rings, those who were believers will be winners.

It is not just me and several analysts who are suggesting you build up your portfolio with this stock. The stock-picking strategy I use based on investment guru John Neff's approach believes Wolseley is smartly priced and worth a buy.

As I mentioned before, you have to be a contrarian to be willing to take a stake in Wolseley, and the Neff strategy has a contrarian streak. It looks for a company's P/E ratio to be between 40% and 60% below the market's P/E. The current market P/E is 19.00, so the acceptable P/E range is 7.60 to 11.40; Wolseley's P/E ratio is 9.94, or 48% below the market. This strategy also wants historical earnings to grow between 7% and 20%. Based on the average of the three-, four- and five-year historical EPS growth rates, Wolseley's EPS growth rate just makes it at 19.8%.

The historical growth rate should be confirmed by analysts' consensus estimate of future growth for both the current fiscal year and the long term of more than 6% for each. The projected future EPS growth rate for Wolseley is 9.2% for the current year and 10.0% for the long term.

And, importantly, earnings growth must be sustained with a corresponding growth in sales. This is true for Wolseley, whose sales growth based on the average of the three-, four- and five-year historical sales growth is 16.5%.

The last variable considered by the Neff strategy is that total return (EPS growth plus yield) divided by the P/E ratio must be at least double that of the market. Wolseley's total return divided by the P/E ratio is 2.26 -- based on the average of its three-, four- and five-year historical EPS growth rates -- which is well more than double the market's comparable figure of 0.69.

Wolseley has certainly been tainted by the real estate bust. It is struggling. But it has a dominant market position and its stock has been hammered. This building materials supplier knows a thing or two about hammers, and at the current price, I think we will look back in the coming years and view this period as a time when the stock was a real bargain.