Economic indicators help investors gauge the overall health of the economy and they can also point to certain sectors that may have growth potential in the near future. Take housing starts as an example. Growth in this indicator can spell good news for the likes of A.O. Smith (NYSE:AOS), Lennox International (NYSE:LII), Home Depot (NYSE:HD)-and even Bed Bath & Beyond (NASDAQ:BBBY).
The numbers of new starts and building permits tend to go up before the economy starts to improve. That's because the costs of homeowner borrowing are lower when the overall economy is weaker. A wave of (responsible) borrowing inspires growth in starts and helps strengthen the economy, which then in turn raises the costs of borrowing.
The housing starts information comes from the Census' New Residential Construction Report, which recently released November's data. The report includes three figures: building permits, housing starts, and housing completions. For a quick read, look only at the single family housing starts, which involve less speculative buying and overall volatility than multi-family units.
For November, single-family starts were up at their highest level since 2008 with nearly 21% growth from October and over 26% growth on the year.
So what can investors do with this data?
An uptick in new home construction means more money for building material providers or installers. Major players include water heater manufacturer A.O. Smith and HVAC provider Lennox International.
A.O. Smith shares have risen over 76% in the past year. The company beat the third-quarter analyst estimates for EPS by over 24% and it also recorded a slight beat on revenue. North American revenue grew by about 10%, but there was triple the growth in the Chinese market. A.O. Smith isn't overly dependent on the growth of the U.S. housing market, but it still stands to gain. The strong third quarter inspired the company to raise its full-year guidance to $2.00-$2.04, which would meet analyst estimates.
Lennox International beat narrowly on EPS in the third quarter but it also reported a slight miss on revenue. In the third quarter, gross margin improved over 2% year-over-year due to higher demand and lower material costs. The company has nonetheless increased its full year EPS guidance to $3.50-$3.75, which would beat analyst estimates if it reported at the higher end.
General building supply stores such as The Home Depot(NYSE:HD) also stand to benefit. The chart above shows that Home Depot tends to move with A.O. Smith and Lennox. Home Depot has beat revenue and EPS estimates for the past five quarters and but the company's full-year guidance of $3.72 would come in under the $3.77 consensus.
Investors comfortable for a longer hold can look at Bed Bath & Beyond(NASDAQ:BBBY), which offers home-decor items that could eventually see an increase in sales once the homes are built and occupied. The trick is that Bed Bath & Beyond is more tied to consumer confidence than Home Depot, and consumer confidence can remain shaky even when housing shows improvement. However, Bed Bath & Beyond shares are up over 30% in the past year and the company beat on second-quarter revenue and EPS estimates. The company forecasts third-quarter EPS of $1.11-$1.16 and full year EPS at $4.88-$5.01. The third-quarter guidance would beat analyst estimates at the high end but the full-year guidance is below consensus.
Or take the risk-reduced basket route with the SPDR S&P Homebuilders ETF(NYSEMKT:XHB), which includes the four companies mentioned here plus 33 other building-related stocks. The fund has a moderately low expense ratio of 0.35% and a 0.5% dividend yield.
Foolish final thoughts
The single-family housing numbers for November were encouraging but there's still some growth potential left. The home-building related stocks -- and ETF -- aren't directly tied to housing starts partly due to international sales. However, the housing starts indicator is still a solid sign that these stocks will continue to climb for the near future.
Brandy Betz has no position in any stocks mentioned. The Motley Fool recommends Bed Bath & Beyond and Home Depot. 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.