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Is It Still Safe To Buy housebuilders Bellway plc, Persimmon plc and Taylor Wimpey plc?

Housebuilding stocks have generated some of the biggest profits for private investors over the last few years.

Consider the gains seen by shareholders in Bellway (LSE: BWY), Persimmon (LSE: PSN) and Taylor Wimpey (LSE: TW):

Company 1yr growth 5yr growth
Persimmon 35% 481%
Bellway 49% 388%
Taylor Wimpey 68% 795%

Many investors thought at least some of these companies would fail after the financial crisis, but the opposite has happened.

Helped by sustained government support, the housing market has boomed, as have profits at all the big housebuilders. Investors who have chosen to sit tight and enjoy the ride have done well.

However, I’ve recently spotted some warning signs which suggest to me that investors may need to start paying closer attention to market conditions.

1. Brick volumes down

Shares in brick producer Michelmersh Brick Holdings fell sharply last month. The firm warned that delivery volumes during the second half of the year were “below previous expectations as a result of a softening of the market”.

2. Insulation sales down

Insulation specialist SIG issued a profit warning last week, wiping 24% off the company’s share price in just one day. In the UK, like-for-like sales rose by just 0.4% during the third quarter.

3. New kitchen sales?

Shares in kitchen supplier Howden Joinery Group have fallen by 10% since the firm’s bullish half-year results were published in July. This could simply be a round of profit taking, but may signify that the market believes underlying growth is slowing. We’ll find out more on 5 November, when Howden is due to publish a trading statement.

What does this mean for housebuilders?

Sales growth at companies such as Michelmersh, SIG and Howden should provide a good indicator of how many new homes housebuilders are building. However, we don’t yet know the whole story.

It may be that the big housebuilders are deliberately slowing their growth rates in order to maintain pricing power. Planning delays and shortages of skilled labour could be causing bottlenecks. It’s also possible that SIG and Michelmersh are exceptions, and the wider market is healthy.

We just don’t know.

However, I do think that housebuilding stocks are starting to look quite fully valued:

Company Price/book
ratio
2015 forecast
P/E
2015 forecast
yield
Persimmon 2.8 12.7 5.0%
Bellway 2.0 10.0 3.3%
Taylor Wimpey 2.6 13.4 4.8%

Persimmon

Persimmon’s assets are valued at 2.8 times their book value. The firm will have to generate a lot of profit from its land bank and housing inventory to justify this valuation. I believe Persimmon’s relatively modest forecast P/E of 12.7 is misleading, as profits are heavily cyclical and are much closer to the top of the cycle than the bottom, at the moment.

However, Persimmon’s 5% yield is attractive the firm has net cash. My view is that these shares remain a hold.

Bellway

I’m less keen on Bellway, which has recently moved into net debt to fund land buys. My view is that housebuilders should be funding their operations from free cash flow at this point in the cycle.

Bellway’s yield is also pretty average. In my view this is one of the less attractive housing stocks.

Taylor Wimpey

Like Persimmon, Taylor Wimpey has a very high price/book ratio. The firm’s forecast P/E of 13.4 is also quite demanding.

However, Taylor Wimpey does have net cash. Free cash flow is strong and the shares have an attractive yield. I believe these shares are worth holding.

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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.