Few can argue with the returns from housing stocks. The group, as measured by the S&P Supercomposite Homebuilding Index, has gained 112% over the past two years, despite warnings along the way that the real estate market was already saturated.

Relatively low interest rates and a steady economic backdrop should help these stocks keep their momentum into the first half of 2005. Unfortunately, none of the major homebuilders trade in the single-digits anymore, so we set our sights on finding other housing-related stocks in the under $10 universe that take advantage of this thesis for the Stocks Under $10 model portfolio.

The most intriguing name we came across was whirlpool bath specialist Jacuzzi Brands ( JJZ). The company derives more than 90% of its revenue from bath and plumbing products, marketed through recognizable brands like Jacuzzi, Sundance and Eljer, while the remainder comes from its Rainbow vacuum cleaner systems. Jacuzzi sells both directly to wholesalers that supply homebuilders, and to retail customers through its relationship with Home Depot, its largest customer, and Lowe's .

Jacuzzi shares are up 21% for the year to $8.58, but have given back 10% since Dec. 1. That values the stock at 15 times expected 2005 earnings, which could prove conservative if housing growth is robust and interest rates remain favorable for borrowers. We are not adding the stock to our model portfolio at this point because we already have 17 positions, but we are placing Jacuzzi near the top of our watch list because we believe shares will trade into the double-digits over the next 12 months.

The company reported September quarter earnings Dec. 9, delivering sales of $343 million and earnings of 18 cents a share. Both numbers are better than the same quarter last year, when the firm recorded revenue of $327 million and earnings of 6 cents a share. While the numbers appeared solid to us, led by margin gains at Jacuzzi's core bath division (two-thirds of total sales), some analysts were less optimistic about the company's quarter, citing "poor earnings quality," primarily related to currency benefits. But just last week, Halpern Capital's David Sterman changed his tone after a meeting with management convinced him the "rebound still has legs."

We believe the rest of Jacuzzi's detractors are wrongfully dismissing the company's improved business structure. President/COO Don Devine, who came aboard in 2002, has spent the past three years cutting operating costs and paying down debt. The company's debt stood at $447 million (163% of common equity) at the end of fiscal 2004, down from $1.23 billion (616% of equity) at the end of 2001.

Jacuzzi funded these repurchases by selling off some businesses in the last few years that helped it exit the swimming pool, water systems and lighting businesses. The company sold a $109 million stake in a manufacturing company to JP Morgan's private-equity group in 2002. And in 2001 the company took in $165 million in cash for its stake in manufacturing concern Amex True Temper.

The company's quality of earnings is an issue that could keep the earnings multiple constrained, because currency-related gains aren't sustainable, but we believe there is upside to the current estimates, and investors with longer-term horizons should focus more on Jacuzzi's solid top-line growth, debt reduction and improved year-over-year operating margins.

As successful as Jacuzzi's restructuring has been, the company's executive suite will experience some changes in October 2005 when current CEO David Clarke steps down after 10 years of service. Even so, we believe the transition period will be relatively smooth, because Devine, who's orchestrated much of Jacuzzi's recent turnaround over the past two years, will step into the chief executive role.

We believe Jacuzzi's shares, thanks to the December decline, are poised to turn in some nice results in 2005. Jacuzzi scores well in our Alpha factor, which determines a stock's ability to make large percentage gains on news. There are only 73 million shares outstanding, but we believe continued strength in the housing sector will lead to increased institutional interest in beneficiaries like Jacuzzi that have not participated fully in the upside of the housing move. When all is said and done, we expect Jacuzzi to trade in the double digits.

P.S. Remember, stocks priced under $10 have the potential to move quickly. So, you might want to get our current recommendations now with a free trial to TheStreet.com Stocks Under $10.

William Gabrielski is a research associate at TheStreet.com and is accredited with a Series 7 license. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback and invites you to send your comments to william.gabrielski@thestreet.com.

Interested in more writings from William Gabrielski? Check out Stocks Under $10. For more information, click here.

David Peltier is a research associate at TheStreet.com In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Peltier welcomes your feedback and invites you to send your comments to david.peltier@thestreet.com.

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