Another Day, Another Easy 47 Percent Gain
By Jared Levy | October 24, 2017 |

Last month, in the aftermath of Hurricanes Harvey and Irma, I recommended a trade that went against the disaster-mania gripping the market. Tractor Supply (Nasdaq: TSCO) was a stock that unjustly benefitted from investor hype surrounding reconstruction efforts. 

Wall Street didn't seem to understand that, despite its name, Tractor Supply doesn't actually distribute tractors or other heavy equipment. And hurricane effects notwithstanding, the stock was overpriced and sitting on shoddy fundamentals. 

TSCO finally fell apart as the reality set in... and our put options hit their target on Oct. 12, just as I predicted. All in all, my Profit Amplifier subscribers and I walked away with a 30.4% gain in just a few weeks. 

My target this week is another company that stands to benefit from the rebuilding taking place across parts of Florida, Texas and the rest of the Gulf Coast... although not to the extent investors seem to be expecting.

Unfortunately, it too has overshot not only the potential benefit of the rebuild, but nearly every single analyst target. Just like last time, I have a plan to snag nearly a gain of nearly 50% from a small downward move in the stock's price. 

The Numbers Just Don't Add Up
USG Company (NYSE: USG) is a leading manufacturer of gypsum-based sheetrock and joint compound, along with acoustical tiles used in commercial type buildings. But the lion's share of USG's revenue (85%) comes from its gypsum products (essentially, sheetrock and drywall).

Back in early August, before Hurricanes Harvey and Irma ravaged the United States, USG was in a downward spiral, with shares reaching lows around $26 multiple times.

However, over the next month and a half, shares jumped above $33 as investors went crazy over sheetrock. This move added close to $1 billion (with a "B") to USG's market capitalization -- about $300 million more than the company earns in gross profit.

In an effort to justify this rally, I took to my scratch paper to do some ballpark math. Do Americans repairing and rebuilding their hurricane-damaged homes really need enough drywall to warrant such a large gain for USG?

Here's what I came up with:

I wanted to make sure I gave USG the benefit of the doubt for these estimates, so I started by assuming every home damaged by the hurricanes would need to be completely rebuilt. (Obviously, many homes will just be in need of repairs, but this assumption ensures we're not underestimating anything.) 

Harvey is estimated to have damaged 203,000 homes, and while there aren't any official numbers for homes damaged by Irma, let's go ahead and set that number at nearly 100,000. That gives us a total of 300,000 homes to completely rebuild.

From there, I decided to assume that every house being rebuilt was in line with the average U.S. home size of about 2,164 square feet, laid out as 15 12-foot x 12-foot rooms with 12-foot high ceilings (everyone loves a good high ceiling). (Each room takes up 144 square feet; 144 square feet x 15 rooms = 2,160 square feet per house.)

Each 15-room house has 38 unique walls, all which need to be completely replaced with fresh, USG drywall. To completely replace every wall in one of these very geometrical houses, we'd need 171 panels of 4-foot x 8-foot sheets of drywall.

(Every wall would use approximately 4.5 panels of 4-foot x 8-foot sheets of drywall; 4.5 panels x 38 unique walls = 171 panels per home.)

OK. So, we know how many panels of drywall we need to completely replace every wall in one home. To rebuild all 300,000 homes damaged by the hurricanes, we'll use about 51.3 million panels of drywall. Each 4-foot x 8-foot sheet represents 32 square feet, for a grand total of 1.64 billion square feet of drywall.

That's a lot of drywall...

Now that we have a ballpark estimate for how much drywall people will be buying, the real question is how much money can USG expect to make from those extra sales?

The next part took a fair amount of sleuthing. USG doesn't mention how much it costs to manufacture its gypsum products or how much it sells those products to big-box retailers like Home Depot (NYSE: HD) and Lowe's (NYSE: LOW). But after scouring through the company's two most recent 10-K reports, I did find something I could use.

For 2016, the company reported selling 5.76 billion square feet of its gypsum-based drywall product, which generated about $966 million in revenue. My calculations put that at about $0.1677 of revenue for every square foot of drywall. 

($966 million / 5.76 billion square feet = $0.1677 per square foot.)

The previous year gave me a similar figure: In 2015, USG generated about $920 million in revenue selling 5.44 billion square feet of drywall, or about $0.1691 of revenue per square foot. ($920 million / 5.44 billion square feet = $0.1691 per square foot.)

Again, to be generous to USG, let's just say that, for every square foot of drywall USG sells, it makes about $0.17 in revenue.

Going off that figure, if USG sold an additional 1.64 billion square feet of drywall to people rebuilding their homes after the hurricanes, it would generate...

(Drum roll, please.)

...$279.1 million in revenue.

That's not an insignificant addition to the company's top line... but it's not nearly enough to justify the stock's 25% jump in price. And that figure -- which is based on some very outlandish projections, including the assumption that every panel of drywall is purchased from USG -- is likely the very best scenario the company can expect.

Even so, those extremely generous assumptions project that USG would only (temporarily) increase revenues by about a quarter of what the stock has gained in market capitalization. Investors have clearly overreacted.

How We're Trading USG
When you factor in competition, existing stockpiles and an increased cost of production to meet faster time constraints, I'd say that $100 million in additional, temporary earnings is a best-case scenario. That would put the stock's price way below $30 a share, right around analysts' consensus target level.

But the real "tell" on this trade is what analysts have been doing since the hurricanes slammed our shores.

Aside from the fact that only two of the 20 analysts following USG rate the stock a "buy," no one has upgraded their recommendation on the stock! In fact, three analysts have downgraded shares (red arrows) since early September. Zacks Investment Research recently dropped the stock to a "sell," as well.

That's bad news for shares, considering that analysts are "long only" and typically optimistic with longer target horizons. They don't "sell short" stocks when they are overbought. All they can do is move to a more neutral or bearish position. But we're seeing more than that, with the average analyst dropping their earnings projections, which are now the lowest they've been all year.

Based on what we are seeing in analyst action and my mathematical projections, USG shares should be trading below $30 per share. I'd say a price around $28 is even more likely.

 

Earnings are scheduled to be released before the market opens on Oct. 26, and there is a high likelihood that USG will have a great quarter, but management has a fiscal and moral duty to caution investors that these gains are likely temporary. That should be enough to send shares back down to at least $30 or technical support at $29.

So when the stock inevitably falls back to earth, we need to be ready to profit. I've selected a put option with several months until expiration, just in case it takes the market a little longer to come to its senses.

Using our option-buying strategy, we can amplify a 9.5% fall in USG's price to $30 into a 47.1% gain in under three months. If you annualize this return, it works out to a truly outstanding 183%. And even if I'm wrong, this trade breaks even at just 4.7% under recent prices, a move I think we can all agree is almost a given.

How You Can Get In On This Trade
While it wouldn't be fair to my premium Profit Amplifier subscribers to reveal the specifics of this options trade in this article, hear me out. My proven strategy could be just what you need to get through the unpredictable times ahead.  

With natural disasters and political turmoil shaking up an already volatile market, it's tough to pin down where you should be investing. But while the rest of the market has been sitting back and hoping for the best, my subscribers and I have spent the year raiding the market, taking more than our fair share of gains. I'm talking about returns of 35% in six days, 29% in four days, 31% in 10 days and 27% in seven days, just to name a few.

Bottom line, my stock market raiding technique is the best way to increase your returns while preserving capital and reducing risk. Of course, that's only if it's done correctly. 

That's why I created a special report that will walk you through the steps I take when going on market raids, which should help you avoid the costly mistakes many new traders experience. If you'd like to make trades like the one I described today -- or even potentially make 80% when a stock only moves 8% -- go here.

This article originally appeared on StreetAuthority.

 

Outbrain