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Never turn your back on a falling tree, as any seasoned lumberjack will tell you. (He'll be the one who still has all his teeth.) And never turn your back on a falling tree stock, as some seasoned value investors are saying. For a long time, investing in wood and paper has been about as much fun as lying face down in a vat of pulp. The financial press writes obituaries for beat-up forestry stocks almost every day, including Domtar, Tembec and—until it recently announced a merger with Bowater—beleaguered Abitibi-Consolidated.

So why have some of the smartest value investors been buying them lately? Because they see value in the woods, and so should you. The industry is starting to look a little like the steel industry did four or five years ago, at which point a wave of consolidation and resurgent worldwide demand restored it to good health.

Let's start by acknowledging the problems, however. In lumber, the U.S. housing market bubble has burst, and there's little appetite for new homes. Paper? In the news world, we have those newfangled things called TV and the Internet, which are eroding newspaper readership. Pulp? It's used to make paper. To top it off, there are high energy and fibre costs (fibre—be it from trees or recycled paper— is the feedstock for pulp). And don't forget obstreperous old-style unions and gov­ernment meddling.

Sounds grim, but this often attracts wily investors who can find signs of life in a scorched landscape. Take housing: It's a cyclical business, and the current cyclical trough will turn. Maybe the key is to buy the right stock. How about Norbord? It makes oriented strandboard, a product similar to plywood that is used in home building. Norbord's share price climbed to over $9 in January from $7.77 in October, 2006, and it pays a 40-cent annual dividend. The stock market is supposed to look forward, and some managers see past the downturn. Irwin Michael, who runs the successful ABC Funds, highlighted Norbord in his October newsletter, and it's done well for him so far.

Savvy Vancouver billionaire Jim Pattison has been building up his stake in Canfor for years, and he now owns almost a quarter of its shares. Cundill Investment Research and Jarislowsky Fraser, two other fine money managers, have also added to their stakes in Canfor recently.

What about pulp and paper? It was hard to like anything at Abitibi-Consol idated­—­­no profits lately, massive exposure to newsprint and it was selling crown jewels (as faded as they were) to pay off lenders. The share price declined from more than $40 in 1987 to less than $3 in early January. Yet Third Avenue Management, a renowned, index-beating U.S. value shop, owned about 6% of Abitibi when it announced its merger with Bowater. It's rare that when two companies announce a mer­ger, the shares of both companies jump, but that's what happened. The market appreciated what the new company's heft might do for product prices.

The value hounds are also sniffing at pulp. Fairfax Financial, the insurance con­glomerate headed by deep-value buyer Prem Watsa, owns about 20% of SFK Pulp Fund, including convertible debentures. Since hitting bottom at $3.60 in November, SFK's unit price has climbed to more than $4.50, and the income trust has resumed paying monthly distributions.

Why buy now? Industries that earn poor returns—or no return—for long enough eventually get serious about making money again. That means, in part, shrinking the business, which is a hard thing for a CEO to do. But old facilities are being closed and excess capacity is shrinking. Operating rates in the pulp sector averaged about 95% worldwide in November. With output nearing capacity, pulp prices have climbed.

Shrinking isn't enough, however. The forest industry also needs to consolidate. That makes it easier to retire assets and maintain price discipline, as North America's steelmakers did, beginning in about 2000. The top three producers accounted for about 61% of U.S. consumption in 2005, up from 36% for the top three in 2000. The so-called North American steel cartel may be bad news for customers like auto and appliance manufacturers, and for consumers, but it's created billions in shareholder value.

Forest industry consolidation has begun. In January, Domtar merged with Weyerhauser's fine paper division to create a company that will control about a third of the North American uncoated free-sheet market. This bodes well for high prices. And now there's Abitibi-Consolidated and Bowater's proposed merger. Consolidation will likely accelerate because producers have no choice. As the economics of this moribund industry improve over time, the deep value bets should pay off.