Investing Essentials: Construction Materials

The construction materials business is massive, with a lot of opportunity for timely investors. It's also very cyclical and sensitive to the rest of the economy.

Aug 15, 2014 at 12:00AM

Cemex Plant
Multinationals like Cemex are one way to invest in construction materials. Source: Cemex.

Construction materials sounds like one of the most boring, mundane places to invest. After all, concrete has been around since ancient Rome, right? This may be true, but the reality is, pretty much everything about modern society starts with this incredibly important industry. It's also full of innovation, driven by science, and just as concerned with developing renewable and environmentally sustainable products as organic farming can be. And it's a huge industry. 

In 2014, total construction spending is expected to be nearly $1 trillion in the U.S. alone, making it one of the largest industries, and it's dotted with companies of nearly every shape and size. Add in the fact that construction is still on the soft side as the country continues to recover, and now could be a great time to invest in this cyclical industry. Let's take a closer look at what exactly the construction materials segment is, and maybe you can use that information to find some great places to invest. 

What is the construction materials industry?

Weyerhaeuser Trees

Weyerhaeuser manages more than 20 million acres of tree farms globally. Source: Weyerhaeuser.

Essentially, these are companies that produce raw and finished goods that are used in construction. The industry is largely made up of large companies like global concrete maker Cemex, and wood products giant Weyerhaeuser. You also have steel companies like Nucor, which manufactures a number of products specifically for the construction industry. 

What it's not, however, is building products. This can be a bit of a gray area, but the best way to think about it is that building products tend to be factory-produced finished goods, like lighting fixtures, air conditioning units, cabinets, and other non-structural stuff. Construction materials are often the base components that make up the walls, frame, and foundation of a structure. 

How big is the construction materials industry?

In a word, enormous:

G
Data source: U.S. Census Bureau.

Of course, construction materials is just a subset of this, as the spend above includes all government and private construction, both commercial and residential. The construction materials industry is the foundation of every construction project, whether it's the asphalt for a multimillion dollar highway project, or the gypsum wallboard for a $20,000 kitchen remodel. 

How does the construction materials industry work?

With few exceptions, the products in this industry are rarely sold to the end user. Typically, a manufacturer -- take Boise Cascade, for example -- will produce its product -- like plywood, for instance -- and sell it to a distributor. The distributor will then supply construction professionals, who will use the material to produce a finished good, like a house or an office building. 

Wheel Stopper Flickr Making Things Better

This tire stopper is an example of how removed consumers can be from construction materials companies. Source: Flickr user Making Things Better

Construction materials companies often sell their products to manufacturers, as well, who can use these raw materials to produce finished goods that are incorporated into a final product. For example, a concrete company might supply a manufacturer of parking lot bumpers. The point is, these companies are typically behind the scenes, and not consumer-facing, though many are driven by consumer demand based on the health of the overall economy. 

What drives the construction materials industry?

The table above illustrates quite well how much it's driven by the rest of the economy. The reality is, new construction projects largely rely on a healthy consumer economy. A business won't just build a new warehouse because the owner wants it: It relies on customer demand of its product or service, which is itself a product of a healthy economy to support that demand. 

This, in turn, drives residential construction projects -- as does population expansion. But what it really boils down to is that the construction industry -- and, therefore, construction materials -- is heavily dependent on a healthy, vibrant economy. 

Cash Register Steve Snodgrass

Source: Steve Snodgrass via Flickr

From an investing perspective, this means that companies in this industry can be quite cyclical, riding the wave up in a booming economy, and often faltering on the downturn. These companies, due to the nature of producing these products, often have very high fixed costs. When things slow down, those fixed costs can really hurt the bottom line until fixed costs can be lowered through activities like idling plants and reducing labor headcount. Needless to say, these are hard things to do, and can take a lot of time; that can compound the losses. 

What's the point? Be sure you consider cyclical risk when investing in this industry.

 

Jason Hall has no position in any stocks mentioned. The Motley Fool recommends Nucor. 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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