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10.8 Reasons Barratt Developments Plc May Be A Better Buy Than Persimmon plc Or Bovis Homes Group plc

Housing stocks have performed strongly over the last five years, delivering multi-bagging gains for investors who bought during the grim period between 2009 and 2011.

Back then, housebuilders were clear value buys, but today, the picture is less clear. In this article I’ll explain why I think that Barratt Developments (LSE: BDEV) is a far more attractive buy than Persimmon (LSE: PSN) or Bovis Homes Group (LSE: BVS) in today’s market.

Cheap vs expensive

Housebuilders are cyclical: the UK housing market tends to move from boom to bust and back again, with tedious regularity. Historically, this has never failed, so believing that it will be different this time is a very risky investment strategy.

As a result, it makes more sense to value housebuilders using their average earnings per share over a number of years. One popular method is the PE10, which uses the current share price dividend by ten-year average earnings.

The idea is that if a company’s PE10 is low, it may be attractively valued:

Company

PE10

Barratt Developments

10.8

Persimmon

21.5

Bovis Homes Group

19.5

Source: Company reports

All three of these firms have forecast P/E ratios of 9 or 10, but only one has a low PE10 — Barratt.

In my view, this is a big point in Barratt’s favour, as I’m concerned that Persimmon and Bovis could end up looking expensive, if earnings revert to long-term average levels.

Not just the PE10

The PE10 isn’t the only difference between these firms.

The value of a housebuilder is simply its land, or book value, plus the profit it can make from building and selling houses.

Barratt currently trades on 1.35 times its book value, which seems reasonable, and so does Bovis.

However, Persimmon trades on a whopping 2.4 times book value. This will probably be sustained for a while by Persimmon’s cash return program and strong earnings, but looks risky to me.

What about yield?

The final area where I believe Barratt scores highly is dividend yield. Barratt has a strong net cash position, and its 4.8% prospective yield is likely to be covered by annual free cash flow, as it has been for the last two years.

In contrast, Persimmon’s share price could fall heavily as its cash return program nears an end in the next few years, while Bovis dividends have not been covered by free cash flow once since 2010.

Several housebuilders have recently warned that reservation rates are returning to historic norms, and I believe housebuilders are near the top of their cycle.

In this climate, I’d rather buy Barratt than Persimmon or Bovis.

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Roland Head 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.