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Can Barratt Developments Plc Double Its Profits Again This Year?

housebuildingBarratt Developments (LSE: BDEV) shareholders have seen the value of their shares rise by nearly 50% since March 2013, when the government announced that it was going to start pumping cheap money into the housing market, through the Help to Buy scheme.

Housebuilders have been loving it: in its half-yearly results, Barratt said that 29% of the firm’s completions during the period July – December 2013 were through Help to Buy, a figure that is even higher at some of Barratt’s competitors.

Barratt’s financial year ended on 30 June, and current consensus forecasts suggest that the firm will report adjusted earnings of 29.9p per share — double last year’s figure of 14.6p.

In a year-end trading update on July 10, Barratt said that full year housing completions were at their highest level since 2008, and that forward sales — reservations on incomplete houses — had risen by 44% to £1.2bn over the last year, a repeat of 2012/13, when they also rose by 44%.

What could go wrong?

Although rising land, labour and materials costs could put pressure on Barratt’s profit margins over the next year, I think that the big risk for Barratt investors relates to mortgage financing and interest rates.

While the current government has decided to extend the Help to Buy scheme until 2020, a new government might choose to scrap the scheme after next year’s general election.

Similarly, a rise in interest rates — a real possibility in the next year — could derail Barratt’s massive growth in forward sales, as many would-be buyers might be forced to reduce their mortgage expectations.

Cyclical progress

The key risk for Barratt investors is to value Barratt on its forecast P/E rating — which is less than 10 — without recognising the cyclical nature of the housing market. Housebuilders always look cheap when the housing market is booming, just as they look expensive when it crashes.

In my view, the fact that housebuilders like Barratt look so cheap at present is a warning sign that we may be approaching the top of the cycle, and that profits could soon peak.

Of course, I can’t time this, but it’s worth noting that because average wages continue to lag inflation, many lower and middle-income households are already unable to increase their expenditure on housing.

Where next for property profits?

Investors in housebuilders have had a good run since 2009, and it may soon be time to take some profits. 

When you do, the secret to success will be to identify the next undervalued area of the market.

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Roland Head has no position in any shares mentioned. The Motley Fool has no position in any of the shares mentioned.