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Is the Barratt share price set to return to 700p?

I haven’t been keen on housebuilders such as Barratt Developments  (LSE: BDEV) since the Bank of England began increasing the base rate for lending last autumn. Historically, rising interest rates haven’t generally been good for housebuilders, but there are also other reasons for my bearish view and I’ll come back to these shortly.

First, I have to acknowledge there are positive things about Barratt. It issued a strong trading update last month. Its current share price of 540p is cheap compared with 700p less than a year ago. And its low earnings rating and high dividend yield appear to indicate tremendous value for investors today, if the shares were to return to that 700p level.

Why so cheap?

Barratt has a 30 June financial year-end and is due to release its annual results on 5 September. Analysts are expecting earnings per share (EPS) of 66.1p and dividends (including a special) of 43.7p. The price-to-earnings (P/E) ratio is 8.2 and the dividend yield is 8.1%. This valuation is either too cheap to ignore or too good to be true.

An argument for too cheap to ignore is that the shares are temporarily depressed due to Brexit worries and that the cheap valuation offers a wide margin of safety should Brexit go less than smoothly. However, I’m more inclined to think that the market is beginning to price-in the next crash in the time-honoured boom-and-bust housing cycle.

When Barratt’s shares reached 700p last year, the price-to-tangible net asset value (P/TNAV) was 2.1, which is the sort of valuation we find at the top of the cycle. At the bottom, we tend to find the stock at a discount (P/TNAV below 1). Despite the decline in the shares, Barratt’s current P/TNAV of 1.5 suggests they could have a lot further to fall, when the next bust comes over the horizon.

Rising interest rates and Barratt’s elevated P/TNAV lead me to view its current cheap P/E and high dividend yield less as too cheap to ignore and more as too good to be true. As such, after a decade of terrific returns, I’d be inclined to sell the shares and bank profits at this stage.

A stock to hold?

If I were looking to hedge my bets and retain some exposure to the housebuilding sector, Henry Boot  (LSE: BOOT), which released its half-year results today, is a stock I’d be happy to hold.

The group has a strategic land arm and a housebuilding joint venture, but also has several other businesses: commercial property development, construction (public and private sector), plant hire, and a long-term contract with the Highways Agency to operate and maintain the A69 trunk road between Carlisle and Newcastle.

The shares are trading 3.5% higher at 280p on the back of today’s results but are still well below their 52-week high of near to 350p. The company reported a 20% rise in EPS for the six months ended 30 June and the board lifted the interim dividend by 14%. The trailing 12-months EPS and dividend are 34.7p and 8.4p, respectively. The P/E is 8.1 and the dividend (covered over four times by earnings) gives a yield of 3%.

Boot has reduced its borrowings significantly over the last year. It now has, as management said today, “a prudent level of gearing which, in our view, is vital at this stage of the economic cycle.”

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.