Investor Essentials Daily

The market cannot differentiate between homebuilders and other construction companies, making this stock undervalued

November 29, 2022

The outlook for the housing industry is not that bright, making investors worried about construction companies.

However, they miss that the construction industry includes not only home builders but also a lot of other names exposed to commercial and industrial investments.

One of these companies is Simpson Manufacturing Co. (SSD). It is poised to benefit from the Supply-Chain Super Cycle, which will allow the renewal and replacement of the current supply chains and facilities.

The market still values this name as a regular construction player that is going to continue the same way, resulting in low valuations.

That’s why it showed up on our FA Alpha Screen. Its high quality, impressive returns, and low valuations make it an interesting name.

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After a long period of rising housing prices and high demand for new houses, it seems we have reached a saturation point. Demand and prices have been slowing down recently.

Undoubtedly, the construction industry has been affected by this. The Homebuilders index is down nearly 30% year-to-date.

With surging inflation and mortgage rates, people are worried that the outlook of demand for new properties is not bright, and they might be right.

Not only are loans becoming more expensive, but people are also avoiding big investments to save money with fears of a recession.

However, there is one thing they miss about the construction industry. It does include not only home building but also commercial and industrial investments.

Especially with the supply-chain supercycle, this part of the construction industry will be much more important.

The pandemic made companies realize how exposed their supply chains were to an economic slowdown. Now, they are investing in their supply chains to make them more resilient and bringing their manufacturing facilities home to decrease lead times.

This means more demand for construction companies operating in the commercial and industrial fields.

A great example of these companies is Simpson Manufacturing Co. (SSD). It manufactures and sells wood and concrete construction products in a wide range of regions, including the U.S., Canada, the United Kingdom, and the rest of Europe.

The company’s return on assets (“ROA”) has been consistently increasing since the Great Recession in 2008 and 2009. It dropped from 13% in 2019 to 8% in 2020 because of the impacts of Covid. However, it managed to recover quickly, reaching 2018 levels of 12%.

The company is in a perfect position to benefit from the investments in the supply-chain supercycle. However, the market doesn’t seem to realize this.

Currently, the stock is trading at a 15x Uniform Price to Earnings (P/E). This is the lowest ratio in the last decade, with the exception of the pandemic period, and it is much lower than the historical average of 20x.

If the company manages to be one of the main suppliers for the new construction projects that will happen in the next decade, it will enjoy booming demand and increased profitability.

The high quality, impressive returns, and low valuation mean that Simpson Manufacturing is a great candidate to become an FA Alpha name.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.

The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.

That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

See for yourself below.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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