Michael Shulman

Homebuilders Helped Us Construct Profits

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Think about it -- why were the homebuilders hurting? Because people aren't paying their mortgages, which means more existing homes are standing empty and, thus, demand for new homes to be built is non-existent.

And that, my friends, opens up some very fertile short-side ground. Why? Well, if new homes are not being built, then the companies that supply building materials don't have anyone to sell their products to.

The home-renovation market is impacted by how housing stocks are performing. That is, when housing is in the tank, it takes down its suppliers, which serves as the cherry on top of the short-side sundae for those of us who are buying put options on these troubled companies' stocks.

Based on this premise, in September 2007, I identified a trio of building supplier kings -- Louisiana-Pacific (LPX), Masco (MAS) and Universal Forest Products (UFPI) -- whose stocks I was certain we would be yelling, "Timber!" as they fell.

Masco manufactures all of the stuff that goes into both new and renovated houses -- i.e., building materials, windows, wallboards -- and the stock was in a steady decline since May.

It was a big, $12 billion to $13 billion outfit that was profitable -- but its business prospects became so bleak that it was too good of a short-side opportunity to pass up.

Masco was a market leader, and one that's very solidly run. For this reason, lots of value investors piled in, thinking that they were getting shares "on the cheap." But those bargain-hunters were wrong.

Oftentimes, we establish short-side positions in poorly run companies, but when good ones like this are losing people to sell their products to, this sets up a great "short" outlook.

We invest on failing fundamentals, not on what the charts say, so with the stock trading at $24, my research told me that the stock would dip to $15 long before it would spike to $30. And because of its stance as a strong company, its puts were dirt-cheap -- in fact, it only cost 95 cents to buy its April 20 Puts.

So, while the value guys were thinking they were getting a good deal on the shares, I knew my short-side investors would be the ones laughing all the way to the bank instead.

And laugh, they did -- we held the position from Sept. 12 through Jan. 10. And in those four months, our 95-cent investment more than doubled to $2.10 for a not-too-shabby 121% gain.