Shares of UK-focused housebuilders such as Persimmon (LSE: PSN), Taylor Wimpey (LSE: TW) and Bovis Homes Group (LSE: BVS) continue their recovery today after falling earlier in the year.
Is this a bounce you should hop aboard or is more caution warranted?
Declining earnings
I’m cautious on the housebuilders and won’t be rushing to buy their shares.
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Looking back to the aftermath of the financial crisis, the housebuilders have travelled a long way in terms of rebuilding and growing their profits and in the way their share prices recovered from the depths that saw them trade with penny share status.
However, the halcyon days of double-digit growth in earnings year after year appear to be over — at least for this wider economic cycle. City analysts following these three firms predict declines in earnings per share for 2017, Persimmon’s to fall by 9%, Taylor Wimpey’s by 6%, and Bovis Homes’ by 6%.
The big advances as earnings recovered look done and forward growth seems set to become much harder for the housebuilders to achieve. Perhaps we’re already seeing peak earnings for the sector in this wider macroeconomic cycle, despite a favourable interest rate environment and an ongoing need for further housing in Britain.
Downside risk
Affordability will likely act as a brake on demand at some point. House prices won’t go up forever and people can’t buy houses if they can’t afford them, even if they need somewhere to live. Perhaps the ramifications of the process of Britain leaving the European Union will upset the balance of variables that has hitherto kept property prices rising. If it does, and property prices start to ease in a significant way, I can’t see such a situation doing the housebuilding firms’ profits and share prices any good whatsoever.
I think it’s dangerous to flirt with out-and-out cyclical businesses after a long period of robust profits. When profits and share prices are elevated, as now, the risk to the downside for investors is at its most acute and the upside potential at its most limited. The stock market as a whole isn’t as stupid as we might sometimes think. The market figured out cyclicality long ago and tries to mark down the valuations of cyclical firms as their profits rise in anticipation of the next cyclical down-leg.
Such valuation-compression will likely drag on investor total returns from here, so is it really worth flirting with the unknown location of the next cyclical plunge that could take away years of dividend gains in capital losses? I don’t think so, especially when there are so many other less cyclical investment opportunities available on the London stock market paying more reliable dividends than the housebuilding companies right now.
The time to invest in uber-cyclical housebuilding firms is when their profits have vanished and their share prices are under the floorboards, such as in the immediate aftermath of the financial crisis. Right now, their businesses look far too healthy, so I’m avoiding them.
