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Warren Buffett Likes This Building Materials Stock

BERKSHIRE HATHAWAYWarren Buffett’s Berkshire Hathaway kept its position in USG Corporation (NYSE:USG) unchanged at just over 17 million shares throughout the second quarter, refusing to take profits as the stock rose 11% in those three months while the S&P 500 fell (see more stocks in Warren Buffett’s portfolio). Year to date USG is up 92% as the manufacturer and distributor of building materials- primarily gypsum products such as wallboard- has benefitted from investor confidence in an impending housing and construction recovery. About half the company’s revenues come from new construction projects, with the rest from remodeling and repair activities.

Other investors are also in the stock, either following Buffett or buying USG because of its housing and construction exposure. Buffett has owned the stock for some time, but “Warren Buffett of Canada” Prem Watsa at Fairfax Financial Holdings just started building his position in the spring of 2011. Fairfax reported in June of that year that it had initiated a position of about 7 million shares, which is still what it held at the end of 2012’s second quarter (find more of Prem Watsa’s favorite stocks). Citadel Investment Group, managed by billionaire Ken Griffin, increased its stake 66% in the second quarter to a total of 4.7 million shares (research other stock picks from Ken Griffin) while Aletheia Research and Management initiated a position of 1.4 million shares.

USG’s 10-Q reported an 8% increase in revenue compared to the second quarter of 2011. This growth was actually weaker than what the company had seen in the first quarter, as first-half numbers indicate that revenue this year is tracking 10% higher. We do worry that some of these improved results could be due to fair weather conditions in the first half of the year, and that construction activity only took place ahead of schedule. If so, then the improved results might not continue in the next couple quarters (or the improvement might not be as large). Furthermore, USG still has not turned a profit: it finished the first half of 2012 with 79 cents per share in net losses, compared to $1.70 per share in losses a year ago. The investment community is moving towards a consensus that there is a housing recovery, but as we have pointed out the stock has rocketed up this year; it may have already captured much of the potential gains. Wall Street analysts expect that by next year the company will have eased into profitability, expecting 12 cents per share of earnings for 2013, but that compares to a current price of $20.23 per share. As might be expected, USG is highly sensitive to the broader market and carries a beta of 3.

USG is a housing and construction play, but as it also benefits from repair and remodeling activity (which should be more stable) we wouldn’t compare it to, say, cement companies. We think that better peers can be found in the form of Sherwin-Williams (NYSE:SHW), Masco (NYSE:MAS), and Owens Corning (NYSE:OC) as paint, home improvement products such as cabinets, and insulation (respectively) are also exposed to both sources of demand. The forward earnings multiples for these companies range from 13 to 25, indicating that they are generally priced for growth as well. However, Masco and Owens Corning are not seeing much improvement in their businesses compared to a year ago while Sherwin-Williams, which we covered in July, reported 27% earnings growth last quarter compared to the same period in 2011. We would advise investors to pick Sherwin-Williams over these other companies unless they strongly favor following Buffett, as the paint and finish company doesn’t need any kind of turnaround to justify its stock price and seems to be doing fine with the housing and construction markets as they are.

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