Home Improvement Stocks to Spiff Up Your Portfolio

Home Improvement Stocks to Spiff Up Your Portfolio

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As investors and economists continue to debate whether the housing market has finally turned for the better, they may be overlooking one corner of the business where recovery has taken hold: Home improvement.

“Renovation spending is on a decisive uptrend, which is likely to persist,” retail analyst Denise Choi and Michelle Meyer, senior U.S. economist at Bank of America Merrill Lynch, write in a report published this week. Indeed, the downtrend in this part of the real estate business was never as dramatic as that in the construction market: While new home building plunged 80 percent from peak to trough, the two note in their report, spending on renovations declined only 30 percent. Moreover, this part of the business is usually fastest to recover.

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That has been great news for companies like Home Depot (HD) and Lowe’s (LOW), which cater to both the do-it-yourself handyperson and the kind of contractors called in to assist with some of the specialist jobs, from plumbing to electrical work. Both stocks have been on a tear, with Home Depot up nearly 80 percent from its 52-week lows and setting new 52-week highs today north of $50 a share. The gains recorded by Lowe’s have been only slightly less dramatic – the stock is up nearly 75 percent from its lows and also is trading at a 52-week high today – but both companies are reporting big gains in earnings, justifying the movement in the eyes of fans.

In their report, Choi and Meyer argue that the rebound in renovation spending that has fueled gains in sales, profits and share prices of these two bellwether stocks is just getting underway.

There are cyclical arguments in favor of this. The recovery in the jobs market has enabled more families to spend more to repaint a room or replace aging kitchen cabinets. And investors who have picked up foreclosed properties at a discount may be spending to transform those homes into rental units.

But secular shifts are also transforming the real estate market. Normally, about 1.2 million new households are formed each year – and each of those occupies its own physical space, the report notes. The recession has curtailed that, meaning that there’s lots of pent-up demand. Moreover, the aging baby boomers whose home purchases once drove the housing market upward now will increasingly be hoping to downsize. And every time one of those new households is formed, spending on everything from paint and a new pair of blinds to new windows and nails will see another upward jump. These new movers, the report notes, spend 25 percent more on home renovation projects than do any other group of homeowners.

Just in case either Home Depot or Lowe’s needed an additional helping hand, the weather gods have favored them this year. An unseasonably warm winter meant that those homeowners didn’t have to defer renovation projects until spring, and same-store sales have been above the retailing industry’s average levels.

The question now is whether these stocks are likely to falter after coming so far so fast. That’s not impossible, but in the absence of any actual bad news – sales growth rates that seem to falter, or a decrease in profit margins when they report their first-quarter results – the rationale for dumping shares in either at the moment appears unclear. (Of course, it’s also unlikely that the ride from here on out will be free of bumps.) Especially since there are few publicly traded rivals that offer investors as pure a play on the home-renovation phenomenon – the handful that exist are mostly traded on the pink sheets, with little liquidity and potentially even more volatility, but without the same kind of dominant national presence. Owning a company that doesn’t rely on any particular region is particularly vital in any housing-related business, given the industry’s propensity to thrive in one part of the country while languishing in the doldrums elsewhere.

If you don’t want to own the retailers themselves, however, there are plenty of alternatives among their suppliers. Choi and Meyer point to Masco (MAS), a big supplier to both of the chains of kitchen cabinets and faucets, and to paint manufacturer Sherwin-Williams (SHW). If the renovation boom is a lasting phenomenon, both companies stand to gain.