Betteridge’s law states that any headline that ends with a question mark can be answered ‘no’. But in this case, it’s wrong. I do think Persimmon (LSE:PSN) shares are the bargain of the decade. Here’s why.
A bargain stock is usually defined as one that doesn’t accurately reflect any of the underlying earnings, cash flow, assets, or debt of a company.
In the case of Persimmon, I think it’s undervalued using all four measures.
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1. Earnings
The directors are expecting 8,000-9,000 houses to be built this year. At the bottom end of this range, that’s just over half the average for the past five financial years (15,060).
Last year, the profit before tax per completed property was around £68k. Even if this falls to £60k due to inflation and/or a reduction in the average selling price, I think earnings should be around £480m in 2023.
Let’s be even more pessimistic and reduce it to £55k. In this worst-case scenario, pre-tax profits should be around £440m.
This implies a price-to-earnings ratio of around seven compared to an average for the FTSE 100 of 10.
2. Cash flow
Due to its simple business model and funding structure, the company’s free cash flow should be similar to its post-tax profit.
Building 8,000 homes this year should therefore generate cash of around £400m.
Applying discounted cash flow techniques (spreadsheets are available online), and assuming 5% annual growth, a discount rate of 8% and a terminal value equal to seven times’ free cash flow, gives a valuation of £4.1bn.
Even with these very conservative assumptions, that’s 28% more than its current market cap of £3.2bn.
3. Assets
Unlike many large companies, Persimmon’s balance sheet is full of tangible (physical) assets — such as land, work in progress, and cash — whose value is easy to determine.
At 31 December 2022, net assets per share were £10.77 – 11% more than the current share price.
4. Debt
This is a straightforward metric on which to assess the company.
At the end of 2022 it had no borrowings.
There are very few debt-free companies around at the moment.
Good in theory
Irrespective of how undervalued the company’ stock looks on paper, its fortunes remain inextricably linked to the health of the UK housing market. Rapidly rising interest rates and the cost-of-living crisis have reduced disposable incomes and dented confidence.
But we have been here before — the housing market is notoriously cyclical. However, the desire of young adults to get on the property ladder remains undiminished. And, once the UK economy starts to grow again, I’m sure it will pick up quickly.
However, Persimmon’s falling share price — and that of other housebuilders — suggests that investors remain unconvinced that the bottom of the market has been reached.
Also, as the 98th largest company in the FTSE 100, it’s in danger of being relegated at the next reshuffle. Some fund are only permitted to invest in Footsie stocks.
What next?
Shareholders in the company — like me — have had to endure a torrid time lately.
But for the reasons outlined above, I remain confident that investors will soon recognise that the company’s shares are in bargain territory and the price is therefore unlikely to remain below £10 for long.
If I had some spare cash, I’d take advantage and buy some more!
