Building Products: Investing Essentials

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At first glance, the building products industry looks like one of easiest investment sectors to analyze. It's usually seen as a highly cyclical industry whose fortunes are tied to construction activity and the economy in general. That's generally true, but investment in construction projects isn't always going to align perfectly with economic growth. Furthermore, the industry is subdivided between residential and non-residential construction, private and public investment, and new-build and remodeling activity. Growth rates can fluctuate across these divisions, so it's essential to know what kind of exposure a stock has.

For example, large companies with building products divisions, such as United Technologies , Ingersoll-Rand , and Johnson Controls , have broad-based exposure to construction activity. Meanwhile, smaller companies, such as Masco (cabinets and home products), Lennox International (heating and ventilation and air conditioning, or HVAC), and Armstrong World Industries (flooring and ceilings) will be more exposed to specific industry drivers. It's time to look more closely at this multilayered industry

What is the building products industry?

The difference between building products and building materials is a fine distinction. Generally speaking, building products don't contain the structural elements (concrete, steel, roofing, glass, and the like) or supporting fixtures (windows, doors, hand-rails, and so on) used in construction. Building products tend to be industrially mass-produced items, such as heating, ventilation, lighting, plumbing, and flooring, that can be used across many types of buildings.

How big is the building products industry?

The difficulty in distinguishing building materials from products makes it hard to say just how big this industry is. However, to give a sense of the size of the industry, here's a chart of construction spending from the U.S. Census Bureau. Note that at the height of the housing boom in 2006, residential construction spending made up around 60% of total spending, whereas the latest figure is around 38%. The housing boom truly has gone bust.

US Construction Spending Chart

U.S. construction spending data by YCharts

How does the building products industry work?

Essentially, companies in the industry generate revenue through the sale of new products or systems, remodeling of old systems, and servicing systems. Growth rates differ across various sub-sectors of the industry. For example, lighting companies such as Acuity Brands have growth opportunities created by technological advancements in LED lighting, while HVAC-focused companies are more exposed to growth in construction activity, particularly commercial and industrial. Cabinet maker Masco is heavily exposed to new-home building, while Armstrong World Industries' investors are hoping the market for commercial ceilings will come back soon.

In general, a good way to follow events is to monitor the Architectural Billings Index from the American Institute of Architects, the benchmark indicator for the building industry.

What are the drivers of the building products industry?

Ultimately, GDP growth will drive investment in the industry, but that's not the full story. For example, remodeling activity is far less exposed to economic activity than new-build construction is. Moreover, private sector investment is usually more cyclical than public investment. In short, when investing in the sector you will need to be selective about stocks so you can capture the area of growth in the industry.

To demonstrate how this process might work, a look at the most important recent event in the building products industry, the housing boom of 2003-2006, could help. Here is a selection of construction spending covering the period of time from the peak of the housing bubble in 2006 to the middle of 2014, some eight and a half years later:

Type of Construction Spending inJanuary 2006 ($billion) Spending in mid-2014 ($billion) Change From 2006 to mid-2014 Change From mid-2013 to mid-2014
Total $1,163.4 $950.2 (18.2)% 5.5%

Residential

$656.8 $361.3 (45.0)% 7.1%
Non-Residential $506.6 $588.8 16.0% 4.6%
Private $906.9 $685.5 (24.4)% 9.2%
Public $256.5 $264.7 3.2% (2.9)%

Sources: U.S. Census Bureau, author's analysis. All figures are at a seasonally adjusted annual rate. The fourth column demonstrates how spending changed in the 2006 to mid-2014 period, and the fifth shows growth year on year. .

Readers should note the diversity in the growth rates. After more than eight years, spending in the private sector declined 24.4%, but it was up 9.2% on a yearly comparison. A similar dynamic can be seen with the residential sector. On the contrary, the public sector grew 3.2%, but declined 2.9% in the last year analyzed. Meanwhile, the non-residential sector actually improved on both measures.

This analysis of conditions in the 2006 to mid-2014 period of time demonstrates the importance of being selective choosing whether to invest, or how to invest , in the building products industry. The dynamics of the building products industry are more complicated than at first sight. However, the sector can be very rewarding, particularly so if you select a stock exposed to the right area of growth.

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The article Building Products: Investing Essentials originally appeared on Fool.com.

Lee Samaha and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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This article appears in: Investing , Stocks

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