Easy Profits from Investor Hysterics
by Graham Summers
November 15, 2006
They’ve overdone it. Again.
The housing sector is slowing, but investors have already hit the panic button. Homebuilder stocks, mortgage lenders, anything even remotely involved with the housing sector has been brutalized.
Last month, new home prices declined by the largest amount since 1970. Granted, a cooldown is inevitable. After all, we’ve been in a housing boom for five years. But this sell-off is overkill.
Take the homebuilder stocks, for instance.
The three largest homebuilders are D.R. Horton (DHI), Centex (CTX), and Pulte Homes (PHM). All three of these companies have been in business for decades. They’ve seen both boom and bust before. Yet all three of these companies are currently trading near 52-week lows. At these levels, these companies are trading for single-digit earnings.
The telltale sign of investor overreaction is in the 10-year financials for these companies. DHI, CTX, and PHM were already growing in size and profitability back in the mid-90s – long before the housing boom erupted. At that time, all three companies were showing investors double-digit returns on equity.
So even if you discount the increased profitability the housing boom has brought these companies, you’re still talking about terrific companies that have weathered cyclical slowdowns before. And they’re trading at their cheapest levels in years.
It’s an incredible buying opportunity. And corporate insiders are taking advantage of it by loading up on housing’s peripheral sector: materials.
Consumer discretionary, materials, and finance industries accounted for over 60% of insider purchases in October. Now, the finance industry is notorious for granting tons of options, so its presence on the top industry list is nothing to be excited about.
However,discretionary and materials only appeared on my insider radar in the last month or so. The fact that both industries are now in the top three for insider buyers is an extremely bullish sign of future performance. And of the two, materials makes the most compelling investment, with over 40% of the acquisitions in that industry coming from market purchases as opposed to stock compensation or options growth.
If you’re unfamiliar with the materials industry, you can think of it as the supplier industry of the economy. Concrete, aluminum, ventilation ducts, chemicals, virtually any substance that is used in manufacturing or production of other goods belongs in the materials sector.
Because of the short-swing profit rule, corporate insiders can’t sell the shares they buy for at least six months. So insider purchases precede market moves by at least six months. The current action in the materials industry means that 4Q06 and 1Q07 are going to be big quarters for materials stocks.
There are a couple of ways to play this trend. The safest and most stable is to buy the Basic Materials iShares (IYM).
If you’re unfamiliar with iShares, they’re essentially index funds that trade like stocks. In this sense, buying the Materials iShares is like buying a basket of materials stocks with a single transaction.
The Materials iShares gives you exposure to a wide array of sectors: gold, aluminum, chemicals, paper, even timber. This sort of diversification makes this play extremely safe.
If you’re in the market for individual companies, the following are especially popular among insider bulls: Dow Chemical (DOW), Comstock Homebuilding (CHCI), and Carbo Ceramics (CRR). Dow Chemical, in particular, has experienced a ton of insider buying recently.
I think this sector is full of opportunity. In fact, I’m recommending a materials stock to subscribers of Inside Strategist later today.
Good trading,
Graham
