Housing stocks have performed strongly over the last five years, delivering multi-bagging gains for investors who bought during the grim period between 2009 and 2011.
Back then, housebuilders were clear value buys, but today, the picture is less clear. In this article Ill explain why I think that Barratt Developments (LSE: BDEV) is a far more attractive buy than Persimmon (LSE: PSN) or Bovis Homes Group (LSE: BVS) in todays market.
Cheap vs expensive
Housebuilders are cyclical: the UK housing market tends to move from boom to bust and back again, with tedious regularity. Historically, this has never failed, so believing that it will be different this time is a very risky investment strategy.
As a result, it makes more sense to value housebuilders using their average earnings per share over a number of years. One popular method is the PE10, which uses the current share price dividend by ten-year average earnings.
The idea is that if a companys PE10 is low, it may be attractively valued:
Bovis Homes Group
Source: Company reports
All three of these firms have forecast P/E ratios of 9 or 10, but only one has a low PE10 Barratt.
In my view, this is a big point in Barratts favour, as Im concerned that Persimmon and Bovis could end up looking expensive, if earnings revert to long-term average levels.
Not just the PE10
The PE10 isnt the only difference between these firms.
The value of a housebuilder is simply its land, or book value, plus the profit it can make from building and selling houses.
Barratt currently trades on 1.35 times its book value, which seems reasonable, and so does Bovis.
However, Persimmon trades on a whopping 2.4 times book value. This will probably be sustained for a while by Persimmons cash return program and strong earnings, but looks risky to me.
What about yield?
The final area where I believe Barratt scores highly is dividend yield. Barratt has a strong net cash position, and its 4.8% prospective yield is likely to be covered by annual free cash flow, as it has been for the last two years.
In contrast, Persimmons share price could fall heavily as its cash return program nears an end in the next few years, while Bovis dividends have not been covered by free cash flow once since 2010.
Several housebuilders have recently warned that reservation rates are returning to historic norms, and I believe housebuilders are near the top of their cycle.
In this climate, Id rather buy Barratt than Persimmon or Bovis.
However, if you already own shares in a housebuilder and are looking for new opportunities to diversify your portfolio, I’d urge you to consider the firms highlighted in “5 Shares To Retire On“.
These five firms have been hand-picked by the Motley Fool’s market-beating analysts for their significant growth potential and reliable, rising dividends.
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