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Housing Recovery's Uncertain Timing: Wait it Out Under a Hot Shower

An investment in a recovering housing market is surely a great thing to have, even if the news on new home construction continues to depress. Any housing-dependent company that can survive this drawn-out saga of doom with a decent balance sheet has a good chance of racking up big profit gains when recovery kicks in. Whenever that might be.

Value investors need reasonably-priced companies that are strong enough to provide passable financial performance through a construction malaise that may still last for years. But they’re not likely to find them in the traditional housing sectors. Many home builder stocks YCharts Pro marks as “avoid” because the recession tanked their fundamentals. Companies in the general building materials sector tend to have ramped up valuations.

Then there’s A.O. Smith (AOS). Smith, with a market cap of nearly $2 billion, is the world’s largest maker of residential and commercial water heaters. The company has excellent fundamentals and a long history of performance for shareholders. YCharts Pro marks the shares as attractive and significantly undervalued.

Smith is in the middle of a restructuring that will sell off its electric motors division, a core operation that accounts for about a quarter of sales and makes motors for things like air conditioner compressors and furnace fans. Smith has a buyer -- Regal Beloit Corp. (RBC) agreed to pay about $875 million – but the sale has hit regulatory snags. Meanwhile, Smith agreed this month to buy a big competitor in the heater business, Lochinvar. When all is said and done, Smith will be a company focused exclusively on residential and commercial water heaters and water purification systems in about 60 countries.

The mix-up has attracted investors lately, but as the chart shows, huge swings in share price are nothing unusual for this company.

A. O. Smith Corporation Price Stock Chart

A. O. Smith Corporation Price Stock Chart by YCharts

That latest up and down followed an earnings report investors didn’t seem to know how to handle. Higher steel prices are cutting into profit margins, and North American water product sales are essentially stagnant. But the excitement about this company lies mainly in China, where it has more a more than 20% market share for water products. Sales there are up 30% in the first six months of this year and are still growing fast. Smith will use some of the gains from the motors sale for acquisitions there and other overseas locations, which sounds like a good way to wait out a U.S. housing recovery.

The company also raised its dividend 14% in July, bringing it to a yield now of 1.54%. While that’s not a dividend worth bragging about, Smith has steadily paid and raised its dividend over the years. That’s quite an accomplishment in this industry.

A. O. Smith Corporation Dividend Stock Chart

A. O. Smith Corporation Dividend Stock Chart by YCharts

Smith has also made money in virtually every quarter over the past five years; another unusual feat.

A. O. Smith Corporation Earnings per Share Stock Chart

A. O. Smith Corporation Earnings per Share Stock Chart by YCharts

Smith’s share price now at about 12.63 times earnings is fairly low for this company, and an outright bargain for a value play in the housing market. Buying Smith now essentially would be a bet on its management; that they will make the right acquisitions, at the right price, and then run them well. If they do this well, the company should pay out for shareholders over time at least as much in good times as it did in bad.

But take a look again at the jerkiness in Smith’s price chart. Even if Smith is a value-investor’s best way in to a housing recovery play, it won’t be an easy ride.

Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

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