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Should You Ride the Construction Boom?

Mark Ingebretsen

If you're one of the relatively few people out there watching construction stocks, you've probably been surprised at their recent price moves.

Check out sector leaders like Lennar(LEN - Cramer's Take - Stockpickr), which went from about $36 to $42 since March, or Del Webb(WBB - Cramer's Take - Stockpickr), up from roughly $28 to $40 during the same time period. Both companies focus on residential construction, probably the softest area of the business right now. Nevertheless, these prices aren't anomalies. By some estimates,the average homebuilding stock has risen 85% vs. a 20% loss for the S&P 500 Index.

Other areas of the construction industry are doing as well or better. Take a look at companies like Jacobs Engineering(JEC - Cramer's Take - Stockpickr), which started the year in the mid-$40s and had a recent price of nearly $70, or Foster Wheeler(FWC - Cramer's Take - Stockpickr), which has tripled in price year to date. No surprise, because both companies are involved in the design and building of oil refineries and/or electric power plants.

Is there still time to jump in? Or are these flash-in-the-pan prices that'll melt down should a recession occur? Whatever side of that bet you take, there's a decent chance you'll find ripe trading volatility in this normally slow-moving sector. The Web sites discussed below can help you pick likely winners and losers.

Bullish and Bearish Signs

But first, what exactly is going on here? For starters, analysts like Merrill Lynch's Fritz Von Carp say that construction spending typically takes off during the last phase of an economic expansion. That's when state and local governments, for example, finally decide -- often mistakenly -- that it's safe enough to fund their wish list of projects. Companies tend to think along the same lines.

What's more, many of these stocks have been sorely depressed throughout the tech-crazed '90s. Also fueling the boom, of course, are lower interest rates. Meanwhile, a 1998 Federal law has allocated $200 billion for highway infrastructure projects and $28 billion for airports, with the money to be spent over the next several years. Finally, California's energy mess and fears it'll spread nationwide are sparking a mad rush to create new power plants and oil refineries.

Not all the news is good, however. Consensus forecasts point to slower construction-industry growth throughout 2001. The Associated Builders and Contractors (ABC), a group that represents some 22,000 contractors nationwide, sees signs of a slowdown starting in 2002. Scott Brown, the group's spokesperson, told me member firms still have a backlog of jobs. But the list is shrinking. The area to watch is commercial construction, he says, which often follows any downturn in housing by three to six months. Just so happens, this year housing starts are expected to drop 2.6% from 2000 levels.

Due Diligence

Whatever happens, if you want to ride construction stocks higher or short them on the way down, the obvious first step is to learn who the players are. And that's not as easy as it sounds. Turns out, only a few analysts cover construction stocks. For example, only four analysts watch over homebuilder Hovnanian Enterprises(HOV - Cramer's Take - Stockpickr), whose stock has tripled over the past 12 months. By contrast, 12 analysts follow retailer Toys R Us(TOY - Cramer's Take - Stockpickr), and 31 keep watch over fiber-optic component maker JDS Uniphase(JDSU - Cramer's Take - Stockpickr).

Lots of players like Hovnanian exist. Yet, oddly enough, there's no index for the U.S. construction sector. I looked. And I even called Standard & Poor's. I was told S&P had a construction industry index but discontinued it. Dow Jones maintains an international index of construction firms, but it's probably not as helpful because the index will likely move from factors that have nothing to do with the U.S. economy.

In lieu of an index, MarketGuide.com does provide a complete list companies within four construction-related categories: Raw Materials; Machinery, including agricultural machinery; Supplies and Fixtures; and Services.

Click on any of the stocks on these lists for a complete breakdown of their financials, news, earnings, and so forth -- all of which should give you plenty of information to perform due diligence on whatever favorites you cull out. One thing to watch out for: Some of these companies have a history of overpromising earnings. Their stock prices suffer long term as a result. For investors going long, it's better to find a company that consistently meets or exceeds expectations, of course. The aforementioned Jacobs Engineering is said to be an example.

Watch a group of these stocks long enough, and you'll start to become something of an expert on the construction business. From there, you need to tap into some aggregate statistics and forecasts. Fortunately, that's a fairly easy task.

Organizations like the ABC and particularly the National Association of Home Builders publish regular, in-depth commentary on market conditions. McGraw Hill maintains a kind of portal site for the construction industry named, appropriately enough, Construction.com. For news about power plant and refinery construction projects, you might also check out the links from a recent Tools of the Trade column on the energy sector.

For the big picture, head to the Census Bureau, which publishes an annual construction industry forecast along with monthly data. Likewise, the Bureau of Labor Statistics tracks employment data in the sector.

What to Look for

How do you make sense of both the company information you find along with the macroeconomic data? Here are two critical areas analysts say you should watch out for: One, companies that indicate they have been successful at automating their design procurement and project management processes should see their margins increase as a result. Two, look for companies with viable plans to find and keep skilled workers. Labor has been a critical issue in the construction business for almost five years now, as anyone who has tried to get work done on a home can probably attest. By some accounts, it will take 250,000 skilled new recruits just to replace those who retire each year.

Buffet Returns

Last week's column about tracking Warren Buffett's investment moves via the Web generated a lot of email, even as Buffett's holding company Berkshire Hathaway reported a 25% decline in fiscal first-quarter profits late last week.

One reader supplied an additional link to news items on both Buffett and right-hand-man Charles Munger. Don't let the French-language site put you off -- American flags highlight English links.

Also, if you didn't attend the recent Berkshire Hathaway shareholder meeting, you can get a sense of what it was like by watching the documentary film Woodstock for Capitalists. View clips at the film's Web site.

Finally, many readers took issue with my inference that Warren Buffett had himself purchased 8 million shares of stock in retailer the Gap(GPS - Cramer's Take - Stockpickr). A call to Buffett central command in bucolic Omaha, Neb., confirmed that, indeed, it was not the Sage himself who had purchased those shares, but Lou Simpson, who manages the portfolio for Geico, an insurance firm that is a subsidiary of Berkshire Hathaway. Some speculate that Simpson is Buffett's heir apparent.