Investing in value stocks can mean going against the trend. I think housebuilder Taylor Wimpey (LSE: TW) could be a good example of this. This FTSE 100 stock has fallen by 35% over the last two years. Sales have slowed and profits are expected to fall by 50% this year. Ouch.
To add to the worry, higher mortgage rates have put pressure on house prices. According to major lenders, prices are already falling.
There are clearly some risks. But as billionaire investor Warren Buffett once said, “widespread fear is your friend as an investor because it serves up bargain purchases”.
I think Taylor Wimpey could be one such bargain. Here’s why.
Strong position
Buffett has often said that he likes to buy “quality merchandise when it is marked down”. The word quality is important here. What I don’t want to do is to invest in stocks that are cheap because they have serious problems.
Fortunately, Taylor Wimpey appears to be well prepared to cope with a period of difficult trading.
The company’s recent 2022 results showed a pre-tax profit of £828m, up from £680m in 2021. Operating profit margin for the year was almost 19%, and the business continued to generate plenty of spare cash.
Although management say that new sales have slowed since last year, the business still had an order book worth £2,154m (8,708 homes) on 26 February. That’s over six months’ sales.
Taylor Wimpey’s finances were also supported by a net cash balance of £864m at the end of last year. Although some of this money could be required to fund land purchases, this cash should reduce the risk of any short-term liquidity problems.
Cheap enough to buy?
Cyclical businesses like housebuilders often look cheap when profits are close to their peak. The reason for this is that the market is already starting to price in the risk of a slowdown.
I can see this with Taylor Wimpey. Based on last year’s earnings, the shares trade on a price-to-earnings (P/E) ratio of just six.
Looking ahead, the picture changes. The latest broker forecasts for this year suggest earnings will fall by 50% to around 10p per share. Based on this estimate, the shares are priced on a more expensive rating of 12 times 2023 forecast earnings.
My analysis of Taylor Wimpey’s past performance suggests that earnings forecasts for this year are likely to mark a low point for the business.
I’m also encouraged to see the stock trading its net asset value of 126p per share. Again, this is a classic indicator of value that’s favoured by Warren Buffett — buying a share for less than it’s worth.
Why I’d buy now
Of course, there are no guarantees here. Predicting the behaviour of the UK’s housing market is not easy.
However, investing in shares always carries some risk. I think Taylor Wimpey shares are already priced for bad news and are likely to deliver attractive returns from current levels.
The company is still expected to pay a 9p dividend this year, giving the stock a prospective yield of over 7%.
Looking further ahead, I expect to see a return to growth in 2024 or 2025, when the housing market may start to recover.
