2 Attractive Materials Stocks With Great Growth Potential

There are growing dividends here, too.

Jul 16, 2014 at 5:45PM

Silica gel. Source: Wikimedia Commons.

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some materials companies to your portfolio but don't have the time or expertise to hand-pick a few, the PowerShares DWA Basic Materials Momentum Portfolio ETF (NYSEMKT:PYZ) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in lots of materials companies simultaneously.

Why this ETF, and why materials companies?
The global economy is recovering from some sluggish years, so materials stocks are poised to see their fortunes improve as construction and infrastructure projects get underway and manufacturing kicks into a higher gear. Our government will have something to do with the sector's future domestically, as President Obama has proposed some $300 billion in long-term transportation spending. Still, the global economy is not yet firing on all cylinders, and the industry can be challenged by volatile commodity prices, government regulations, and more.

This ETF charges an expense ratio, or annual fee, of 0.65%. It boasts a strong past performance, outpacing the world market handily over the past three and five years. The ETF is fairly small, so if you're thinking of buying, beware of possibly large spreads between its bid and ask prices. Consider using a limit order if you want to buy in.

A closer look at some components
On your own you might not have selected U.S. Silica Holdings Inc (NYSE:SLCA) or CF Industries Holdings (NYSE:CF) as materials companies for your portfolio, but this ETF recently counted them among its more-than-30 holdings.

U.S. Silica Holdings
It might be hard to imagine that you can make good money investing in a company that specializes in sand, but U.S. Silica Holdings stock more than doubled in 2013 and is up more than 70% year to date. It provides sand to the industrial and energy sectors, with nearly three-quarters of its earnings recently coming from its oil operations. That's partly due to the controversial practice of fracking, in which sand is used to prop open spaces so that oil and gas can be captured. Demand has been so strong that the company recently ran out of sand and is establishing new mines. Risks include increased fracking regulations that decrease demand for sand.

With a dividend yield of 1% and a forward P/E ratio near 19, U.S. Silica Holdings seems rather attractive, as it's enjoying robust growth rates. If the price seems a bit too rich for you, considering its risks, consider adding it to a watchlist to take advantage of an eventual pullback. Last year, Forbes named U.S. Silica Holdings one of America's best small companies based on its performance.

CF Industries
CF Industries is in the fertilizer business and is focusing more intently on nitrogen, having sold its phosphate business to Mosaic. CF Industries aims to boost its nitrogen production by 25% by 2016. The company has been enjoying low natural-gas prices, as natural gas is an input for nitrogen production. Its financial statements reveal growing operating margins and net profit margins that have topped 25% for several years in a row.

On the other hand, free cash flow has been shrinking, but that's due to capital spending that can be considered investments in the company's future -- such as expanding its capacity. The company's debt level has been rising, as it borrows in order to support its capital spending and share buybacks. (After sporting some 70 million shares in 2011, it recently had 57 million shares.)

CF Industries' stock yields 1.6%, and its payout has increased tenfold over the past three years. With a P/E ratio near eight and a forward P/E near 11, both below its five-year average of 12, the stock is appealing. Between dividends and share repurchases, the company is intent on rewarding shareholders. Just don't expect growth without hiccups. The company faces international competition and expects falling prices in the near term.

The big picture
It makes sense to consider adding some materials companies to your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate its holdings and then cherry-pick from among them after doing some research on your own.

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Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, has no position in any stocks mentioned. The Motley Fool owns shares of CF Industries Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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