Why I’m avoiding Persimmon plc, Taylor Wimpey plc and Bellway plc

Unlike banks and commodity firms, the shares of housebuilders listed on the London Stock Exchange have refused to crash — until now.

For some time, I’ve thought the cyclical bull run for the housebuilders was running too far. To me, shares such as Persimmon (LSE: PSN), Taylor Wimpey (LSE: TW) and Bellway (LSE: BWY) have looked overvalued for a while.

Something has to give

Ignoring the dynamics of bubble prices in London and the south, driven by high-earners and foreign investors who enjoy incomes far above the UK average, I reckon something has to give in the wider housing market. Brexit looks like being the catalyst that starts the ‘correction’. People can only afford to pay top dollar for a home if they’re earning enough. If not, the housing market will likely stall until falling property prices reach an attractive level for buyers once more.

If current weakness in the pound persists, imported food, clothes and other goods could rise in price, squeezing consumer spending power and leaving them with less to pay a monthly mortgage. If the pound weakens too much, we could see interest rate rises to try to support it, which would inflate mortgage payments. Indeed, Brexit looks set to bear down on the property market in several different ways, one of which could be a slowdown in the economy.

Lofty heights

Of course, I didn’t know Brexit would come along to spoil the housing party, but I did know that the housebuilders had been growing earnings in robust double-digits for years. It has also been apparent that house prices are at record highs and the ratio between average house prices in Britain and average homebuyer earnings is running close to six — we haven’t seen that since the peak of the debt-fuelled boom during 2007.

From their lofty heights of strong trading, elevated share prices, and earnings multiple ratings that look too high, the view down is unsettling for London-listed housebuilders. At this point somewhere mid-way through an economic cycle, I’d argue they should be on mid-single-digit P/E ratings and their dividend yields should be sky high. At some point, the housing cycle will turn down again and housebuilder’s shares and profits will likely collapse, so it seems reasonable to expect the stock market to mark down their valuations now in anticipation. However, that doesn’t seem to be happening much. It has been with those other cyclical beasts, the banks.

Remember the ‘dash for trash’?

You might remember the aftermath of the financial crisis when banks, housebuilders and commodity firms saw profits and share prices crash by huge percentages. At the lows, we saw a ‘dash for trash’ as institutional and private investors piled back into the cyclical firms hoping to catch the next up-leg in the cycle. Back then those cyclical firms seemed broken, debt-burdened and profitless, yet it was the right thing to do because the share prices rose, often before operations recovered.

That’s the time to invest in cyclical firms such as Persimmon, Taylor Wimpey and Bellway — as close to the bottom of the cycle as possible. The time to exit is when earnings are high and further earnings growth looks harder to achieve. Perhaps that’s now. To me, the housebuilders are nowhere near ‘trashy’ enough to invest in currently, and there’s a certain ‘inevitability’ about a crash at some point, so why take the risk?

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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.