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With Construction Industry Growth Hitting 4-Month Highs, Is There Still Time To Buy Bovis Homes Group plc, Bellway plc & Berkley Group Holdings PLC?

“Construction output growth rebounds at the start of 2015,” screams the latest news release from the UK Construction Purchasing Manager’s Index, based on research by Markit in conjunction with the Chartered Institute of Procurement and Supply (CIPS).

Markit describes itself as a leading global diversified provider of financial information services, and journalists seeking a story — as well as others seeking a handle on the state of the economy in general — keenly watch the UK Construction Purchasing Manager’s Index, along with other Markit output.

Key points

The report highlights that January data shows growth of business activity, which rose from a 17-month low in December. However, job creation in the UK construction sector slipped to its weakest for 13 months.

We shouldn’t consider such data fixes in isolation. Within the industry, construction firms’ assessment of the business outlook is the second lowest since October 2013, the report asserts. Nevertheless, at 59.1 in January, up from 57.6 in December, the seasonally adjusted Markit/CIPS UK Construction Purchasing Managers’ Index® suggests a robust and accelerated expansion of overall business activity at the start of 2015, the report reckons.

Buy (or bye, bye) builders?

So, should we take this as a sign to buy, or get back into the housebuilders? Or should we quit while the going is good and sell into sector strength?

Last year, I sold all my own shares in the housebuilding firms after a great run. With the latest share-price surges in the sector, that could end up being a mistake. However, with housebuilding firms operating in one of the most cyclical sectors, I was worried that valuation compression might drag on shareholder returns even as profits rise.

The market worked out cyclicality long ago and tends to adjust for it. That means P/E ratings of firms such as Bovis Homes Group (LSE: BVS), Bellway (LSE: BWY) and Berkley Group Holdings (LSE: BKG) tend to fall as year-on-year profits rise in anticipation of peak earnings — the top of the cycle. Paradoxically, low P/E ratings and high dividend yields can be markers for a cyclical top rather than a good-value entry point for the shares of highly cyclical firms. That said, we can’t deny that these firms’ shares still seem to be rising, with many predicting more to come. All I’m saying is be careful if you enter the sector now, as cyclicality can mess things up — especially when the share price is far from its most recent cyclical bottom, as now.

Not a long-term hold

I reckon it’s best to trade the cyclicals, such as housebuilding firms, on a short-term basis to try to catch the up-leg of the economic and trading cycles. When I see Bovis Homes Group’s forward P/E rating at just over eight, Bellway’s at just under nine and Berkley Group Holdings’ at nine or so, as now, the alarm bells ring. All three companies pay generous dividends, justified by their gargantuan earnings, too — it all seems to add up to a potential value-investing honey trap.

One of the biggest parts of earning consistent gains on the stock market is to avoid capital loss. I’m concerned that the big share-price gains we see now with housebuilders could reverse, even as earnings grow.

So, rather than investing in potentially dangerous cyclical housebuilders, this Motley Fool wealth report showcases five firms with solid dividend- and capital- growth potential. Our top analysts scoured the market to find companies with reliable cash flow, solid trading positions and great prospects. These are some of the least-cyclical firms on the London stock exchange and you can find out more about them by clicking here.

Kevin Godbold 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.