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General building material stocks appear promising for constructing* net-short positions because stocks in this industry produced below-trend average return on equity for their price-to-book multiples. (This is based on a prior article, which used a top-down approach to identify industries for long and short positions.) Using this top-down approach as a starting point for constructing a net-short position, attractively-priced stocks and overpriced stocks were identified in the general building materials industry.

Alpha hunters might consider net long positions in industries trading at attractive prices, market neutral positions for fairly valued industries, and net short positions in industries with substantially unattractive valuations. If they are willing to hedge their positions, they can find more investment opportunities than they would by just hoping to find the best stocks to buy today. Instead, they can use fully or partially hedged positions to bet on the mean reversion of different stocks in an industry, while minimizing or reducing exposure to industry and market volatility.

Plots of companies within the general building materials industry reveal that there are some stocks which are more attractively priced than others:

(click to enlarge)ROE vs. PB

(click to enlarge)Sales Growth vs. PS

(click to enlarge)Growth vs. PE

In each of these graphs a measure of quality or growth is plotted on the y-axis as a function of a measure of cheapness on the x-axis. Historical price-to-earnings multiples, price-to-book multiples, and price-to-sales multiples were used as measures of cheapness. Analyst estimates for earnings growth, historical return on equity, and historical sales growth were plotted as measures of growth or quality. More attractive stocks are found up and to the left while less attractive stocks are found down and to the right.

Two above-trend stocks are presented in bold and three below trend stocks is listed in red:

Ticker

Company

Country

P/E

P/S

P/B

Growth Est

Sales Growth

ROE

AAON

AAON

USA

22.5

1.6

3.4

10.0%

2.8%

16.2%

APOG

Apogee Enterprises

USA

55.0

0.7

1.5

8.5%

-3.2%

2.6%

AWI

Armstrong World Industries

USA

21.5

0.9

3.7

13.4%

-3.6%

12.9%

FAST

Fastenal Company

USA

32.4

4.3

8.0

17.1%

8.9%

26.9%

GFF

Griffon Corporation

USA

33.7

0.3

0.9

27.0%

6.6%

2.5%

LXU

LSB Industries Inc.

USA

11.9

1.1

2.5

10.0%

10.4%

25.5%

MDU

MDU Resources Group

USA

18.5

1.0

1.5

8.4%

0.2%

8.1%

MLM

Martin Marietta Materials

USA

60.7

1.9

2.5

7.1%

-4.7%

4.1%

NX

Quanex Building Products

USA

5.8

0.3

1.5

15.0%

19.2%

14.2%

OC

Owens Corning

USA

24.5

0.7

1.1

14.2%

-0.2%

4.5%

SHW

Sherwin-Williams

USA

28.8

1.6

9.6

15.7%

2.3%

34.9%

TREX

Trex Co. Inc.

USA

3071.0

1.7

4.3

32.2%

-4.6%

1.7%

UFPI

Universal Forest Products

USA

31.3

0.4

1.3

10.0%

-7.3%

4.2%

VMC

Vulcan Materials Company

USA

0.0

1.9

1.3

8.8%

-5.2%

-2.0%

LXU and NX were found to lie among stocks in the upper left of these plots (higher quality, undervalued stocks) while APOG, MLM, and TREX were found to lie at the lower right of these plots (lower quality, overvalued stocks). Based on this work, a net short position in the agricultural chemicals industry can be constructed by buying LXU and NX shares while hedging with a larger total short position in APOG, MLM, and TREX.

*Pun intended.

Please read the article disclaimer.

Source: Building Material Stocks: 2 Buys And 3 Sells