The Barratt Developments (LSE: BDEV) share price is flying. It ended yesterday at yet another new post-financial-crisis high of 792p. The shares of fellow FTSE 100 housebuilders Persimmon (LSE: PSN), at 2,850p, and Taylor Wimpey (LSE: TW), at 210p, have likewise been on a tear.
Is the rally set to run and run? Or is this a good time for investors to bank profits?
Strong rally
Since the UK voted to leave the EU in 2016, market sentiment towards builders has waxed and waned. We’ve had spells of optimism and pessimism. However, after a period of weakness last winter, builders have rallied. Barratt’s shares are up 82%, Persimmon’s 53%, and Taylor Wimpey’s 62%.
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Furthermore, their performances over the last 10 years have been outstanding, with gains of 486%, 491% and 405% respectively. Shareholders have also enjoyed juicy dividends.
Help to buy
In their last annual results, the three companies reported further increases in margins and returns on capital employed. Indeed, such metrics have reached historically unprecedented levels in recent years.
I think it’s no coincidence these sky-high metrics, and a parallel surge in house prices, have occurred since the government introduced the Help to Buy scheme in 2013. I share the view of analysts who argue housebuilders’ big profits and dividends have effectively been subsidised by the taxpayer.
Such dysfunctional market interventions by governments may act as stimulants in the short term. But ultimately a point tends to be reached where the drugs don’t work anymore. I think we’ve reached this point with Help to Buy.
The market lapped up the asset-inflating distortion it created. For several years, house prices (and housebuilders’ profits) raced ahead of average wage growth (and builders’ cost inflation). This now appears to have run its course. According to Nationwide, annual house-price growth peaked at 11.8% in June 2014. As of December 2019, it’s running at just 1.4%.
Ominous outlook
Taylor Wimpey issued a trading update earlier this week, ahead of its 2019 results (scheduled for 26 February). Commentators saw plenty of positives in the numbers. However, what caught my eye was an operating profit margin for the year of 19.6%. In 2018, it had been 21.6%.
I think this is ominous, and not just because a drop of two full percentage points is hefty. It’s the first annual margin contraction since the one that predated the last housing slump over a decade ago.
Furthermore, despite continuing full-blown Help to Buy in 2020, City analysts are forecasting margin falls across the board at Barratt, Persimmon, and Taylor Wimpey. And I reckon the situation will become still more challenging in 2021. This is because Help to Buy will be restricted to first-time buyers only, and there’ll also be regional caps on prices.
Buy low and sell high
Some investors are happy to buy and hold stocks forever. However, in the most highly cyclical sectors, such as housebuilding, I prefer a strategy of buying low and selling high. This means buying stocks when margins and returns on capital are at, or near, bottom-of-the-cycle levels. And selling when such metrics are at, or near, top-of-the-cycle altitudes.
Personally, if I held shares in Barratt, Persimmon, or Taylor Wimpey at this stage, I’d be happy to sell and bank profits. I’m confident another opportunity to buy low and ride the next up-cycle will come along in due course.
