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Here’s Why Some City Analysts Are Downgrading Housebuilders: Persimmon plc, Barratt Developments Plc, Taylor Wimpey plc, Bellway plc & Bovis Homes Group plc

Amidst a slew of positive new year trading updates from housebuilders, broker Jefferies caused a bit of a stir by downgrading the entire sector, including estate agents and property portals.

Jefferies said “we are no longer recommending that investors buy any of the UK residential-linked shares under our coverage”.

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Should investors turn their backs on housebuilders Persimmon (LSE: PSN), Barratt Developments (LSE: BDEV), Taylor Wimpey (LSE: TW), Bellway (LSE: BWY) and Bovis Homes (LSE: BVS)?

The analysts at Jefferies explained:

“We believe that negative newsflow on UK mortgage approvals, UK housing transactions, weak house price data and lower UK gross domestic product growth will lead to share price weakness in the UK residential sector in Q1 2015, and that uncertainty around the UK general election in May will see this weakness continuing into Q2”.

Elsewhere, analysts at Credit Suisse have warned that the current “favourable disconnect” between house prices and land prices is not a “permanent new normal”, while their counterparts at UBS, though more sanguine, have noted that 2015 housebuilder earnings forecasts imply a return to peak profit margins, and caution against valuing housebuilders “on peak levels of profitability, in what remains a highly cyclical sector”.

The shares of FTSE 100 firms Persimmon, Barratt and Taylor Wimpey have fallen 6% since Jefferies released its note, while FTSE 250 pair Bellway and Bovis are down 10% and 11%, respectively. So, let’s look at some current valuation numbers:

cap (£bn)
price (p)
P/B* P/E** Earnings
Persimmon 4.5 1,449 2.5 9.9 21%
Barratt 4.3 426 1.7 9.2 26%
Taylor Wimpey 4.1 125 1.7 8.7 34%
Bellway 2.2 1,709 1.5 7.9 22%
Bovis 1.1 768 1.2 7.5 31%

* P/B (price-to-book) based on net tangible assets at last balance sheet date.

** P/E (price-to-earnings) based on calendar year (2015) forecast earnings, as the companies have different financial year ends.

*** Earnings growth is forecast growth from calendar year 2014 to calendar year 2015.

On the face of it, the sector looks hugely attractive. All five companies are not only below the “bargain-basement” P/E threshold of 10, but also are forecast to deliver outstanding earnings growth in the next 12 months. In addition, the companies are throwing hod-loads of cash to shareholders by way of dividends.

Have Jefferies’ and Credit Suisse’s concerns about the housing market been priced in, and are the shares at enough of a discount to peak earnings to make the companies attractive investments at this stage in the cycle?

UBS, which uses a “15% discount to peak returns in our normalised valuation”, believes so. And, as the table summarising broker recommendations below shows, plenty of other analysts agree.

  Positive Neutral Negative
Persimmon 6 7 3
Barratt 7 7 1
Taylor Wimpey 12 4 0
Bellway 9 7 0
Bovis 10 1 0

Source: Digital Look

The weighting of broker recommendations fits very closely with the valuations of the companies in my earlier table.

Overall, City sentiment is strongest for Bovis (lowest P/B, lowest P/E, and second-highest forecast earnings growth). Of the FTSE 100 three, Taylor Wimpey is the best-valued and has the strongest analyst support.

Nevertheless, there's undoubtedly plenty to ponder about cyclical sectors, such as housebuilders and banks, at this stage of the UK's economic recovery, which could make 2015 a tricky year for increasing your wealth in the stock market. But don't despair!

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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.