FTSE 100 housebuilder Persimmon (LSE: PSN) is one of several stock-market-listed firms engaged in building new homes that I would avoid like the plague right now.
It’s not that I can fault Persimmon’s operational progress lately. The company has an impressive multi-year record of rising revenue, profits and cash flow. And it’s been good at lavishing its shareholders with dividends along the way.
Could it end in tears for shareholders?
However, there’s a fundamental truth about Persimmon, and the other housebuilders that I can’t ignore. The sector is cyclical, with profits, share prices, cash flows and dividends rising up and falling down in regular waves over the years and decades – it’s always been like that, and I reckon it will continue to be like that.
But it’s more than just an awareness of regular cycles that bothers me. I fear we could be in the middle of the mother of all cycles in the housebuilding sector. In the wake of last decade’s credit-crunch and the recession that followed, the share price for Persimmon, and other housebuilding firms plunged so dramatically and so far, that it looked like the underlying businesses must be in deep trouble – think 90%-plus falls in many cases.
Yet gradually the housebuilders clawed their way back operationally and their shares followed to reflect the progress. But it went too far the other way because the government piled on stimulus to help the sector, such as Help-to-Buy, and kept interest rates very low ever since the financial crisis.
The outcome, in my eyes, is that we’ve seen a bubble in property prices and in the profits of firms such as Persimmon. Look no further than the excessive bonus around £75m given to ex-chief executive Jeff Fairburn a couple of years ago for evidence of how silly things had become.
What if we return to ‘normal’ economic times?
I think the housing market in the UK and the fortunes of the big housebuilding companies are closely tied to the government’s monetary policy. If interest rates return to higher levels we could see the property market and housebuilding firms begin to struggle. I think that’s what the stock market is worried about right now and why it has been marking down Persimmon’s share price.
Indeed, after a long period of high profits, cyclical firms tend to move to lower profits because it’s a cycle! But timing an entry into a cyclical share such as persimmon is notoriously difficult if you are to catch the next up-leg. However, arguably the worst-possible time to go in is when profits have been high for a long time – to me, that’s right now with Persimmon.
It sounds un-Foolish to talk about trying to time an entry into a share and to trade it for the up-leg. But one thing I’m certain about, I don’t want to attempt to buy and hold an out-and-out cyclical stock such as Persimmon. I reckon the outcome from such an investing strategy would be unpredictable and fraught with risk. So I’m avoiding Persimmon shares.
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Kevin Godbold has no position in any share 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.