Investors often follow the latest trends in the U.S. economy and attempt to align their portfolios with the best industries, some of which could have a breakout in the coming months. The construction industry is one example, as the ISM Manufacturing PMI index and its cousin, the ISM Services PMI index, indicate a new expansionary trend in the space.
The Oracle of Omaha, Warren Buffett, spotted the surge in construction stocks in the third and fourth quarters of 2023. So far, the old value investor has yet to be proven wrong, as the sector pushed its third consecutive month of expansion in the Services PMI. Over in manufacturing, the wood products sector flattened due to a jump in new orders.
Homebuilding creates opportunities for all materials involved in the process, mainly wood and other metals. Likely to be a trend until the end of 2024, the expansion of housing and construction demand can seal potential gains for REITs Rayonier Inc. (NYSE: RYN) and PotlatchDeltic Co. (NASDAQ: PCH), and specialty retailer Floor & Decor Holdings Inc. (NYSE: FND).
Following Wall Street's Message
Analysts at The Goldman Sachs Group Inc. (NYSE: GS) warned of a manufacturing breakout in the United States in their 2024 macro outlook report. While not specific to housing and construction, the opinion counts.
This belief came from the expectations of interest rate cuts this year. The Federal Reserve (the Fed) expects to see three cuts by the end of the year, and many traders think they could come as soon as May or June 2024. Trader expectations can be gauged using the CME Group Inc. offers (NASDAQ: CME) FedWatch Tool.
Because lower interest rates could bring mortgage rates down, it makes sense a breakout in homebuying activity could soon follow. Knowing this, investors shouldn't be surprised that Goldman bought Rayonier and Potlatch stock in the past quarter. As of March 2024, the investment bank added 22.9% to its position in Rayonier, an approximate $1.7 million investment. For Potlatch, Goldman saw fit to increase its exposure by 3.7%, or $412,000.
Other known asset managers like the Vanguard Group and the American International Group Inc. (NYSE: AIG) saw it best to choose Floor & Decor instead. Vanguard's vote of confidence came in a 3.2% boost, $34.5 million in total additions. AIG increased its total investment in the stock to $16.2 million, showing Main Street where the professionals are choosing to allocate their own capital.
The Market Agrees, These Are the Winners
Because these holding reports reflect the positioning by the banks over the past three months, investors could be misled as to what is happening. Two ways that Main Street can check the market's point of view on Wall Street's moves are through valuations and earnings per share (EPS) expectations.
The construction sector is valued at a price-to-earnings ratio (P/E) of 19x today. Therefore, any stock trading at a higher valuation can be considered the premium choice. The saying "It must be expensive for a reason" applies here, making these stocks winners.
Rayonier stock can be bought for 66.6x P/E, a 250% premium to its peers. Of course, these valuations can only be justified by above-average EPS growth. While the construction industry expects to see 10% average EPS growth in the next 12 months, analysts think Rayonier can push for 23%.
The story stays the same with Potlatch, as the stock's 68x P/E represents a 257% premium to the sector. Like Rayonier, analysts think Potlatch's EPS can jump 29.4% this year, nearly three times the industry average.
Vanguard's favorite of the three, Floor & Decor, trades at 62.6x P/E for a 229% premium. This stock calls for the most aggressive EPS expansion of 40%, four times the industry average.
Knowing this, analysts at Bank of America Co. (NYSE: BAC) boosted their price targets to $140 a share, calling for a 15% upside from the stock's current price.
Bullish Momentum Confirms Trend
Because all three of these potentially winning stocks trade at 80% or more of their 52-week highs, investors can connect Wall Street's fundamental thesis with some of the technical factors. Bullish momentum is present for all three names to confirm the potential new trend in the sector.
