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USG Corporation (USG) [the old US Gypsum] has been hit hard by the housing downturn. EPS fell from a cyclical peak of $11.01 in 2005 when the boom was still in place to just $1.04 in 2007. Current estimates are widely varied but the consensus view is for a loss this year of ($1.30 - $1.40) and perhaps another losing year of ($0.26 - $0.49) in 2009.

As of March 31, 2008 Berkshire Hathaway held over 17 million shares or about 19% of the shares. While few people predicted the ferocity of the housing decline well in advance the signs of a stock price that was too high back in 2005 – 2006 were clear to those who paid attention to historical valuation parameters for USG shares.

As with most cyclical stocks, USG traded at relatively low P/Es when earnings were strong and higher absolute multiples when earnings were punk.


Here is a chart showing the historical data on USG from 2000 onward.


Year……..High Price …Low Price……..EPS ………Avg. P/E
2000 ………$46.90 …….$13.10…….…$6.48 ………. 4.8x
2001 ………$24.80 …….$2.80 …….....$1.01 ….……. 9.7x
2002 …….…$9.10 ..…... $3.30 ………..$3.22 ………. 1.9x
2003 ………$23.70 …….$3.80 ………..$3.19 ………. 3.8x
2004 ……... $41.70 …….$12.30 ………$7.26 ………. 2.8x
2005 ……... $71.30 …….$26.80 ……...$11.01 ……… 4.4x
2006 …….. $121.70 ….. $43.70 ……... $6.53 ………. 10.6x
2007 …….. $58.70 ……..$34.70 ……… $1.04 ……... 42.8x


Investors who bought USG shares in early 2006 when trailing earnings were over $11 might have thought they were getting a good bargain on a growth stock at just 11x previous year's EPS. However, that eleven multiple was higher than USG had ever commanded when earnings were good. USG typically sold for 3 – 7 times EPS in boom times for builders.

The one brilliant move that USG management did was to give its shareholders a rights offering to buy newly issued shares at $40 on

July 27, 2006. By giving out rights to buy new shares at the then below market price of $40 they ensured virtually 100% subscription to the offer.

At year-end 2005 the book value of USG was negative at (-$6.77/share) and there were 44.64 million shares outstanding. By year-end 2007 USG's book value had been pumped up to a positive $22.14/share through the anti-dilutive rights offering. As of December 31, 2007, there were 99.05 million shares outstanding.

Investor who took the new shares and sold shortly thereafter did well. Those who exercised their rights but held on have suffered losses. USG shares closed at $34.18 yesterday, May 23, 2008.

Anyone who has held these shares since their peak in March 2006 has seen their market value plunge by 71.9% over the past 26 months. While the housing market will eventually recover USG shares have no dividend yield and no prospects for positive earnings anytime soon.

What's the lesson to be learned here? Cyclical shares need to be sold when everything looks rosy and only likely to get better. It's hard to investors to exit these stocks at the top because all the headlines are positive and the macro-environment couldn't look better.

That's why keeping an eye on valuation metrics for your holdings versus historical norms for the same companies are so critical.

Warren Buffet and Berkshire Hathaway shareholders certainly would have been better off today had he sold these shares 2 – 3 years ago instead of following his "My favorite holding period is forever" policy.


Disclosure: No position in USG.

Source: USG Corp: Another Buffett 'Failure to Sell' Mistake