Shares in two of the UK’s largest housebuilding groups, Persimmon (LSE: PSN) and Taylor Wimpey (LSE: TW), look deeply undervalued. According to my calculations, they have the potential to produce a total return for investors of more than 30% next year.
Income and growth
My forecast is based on a combination of their income and capital growth. At the time of writing, City analysts expect Persimmon to distribute a dividend equivalent to 10.5% of its current share price next year. Meanwhile, Taylor Wimpey is scheduled to throw off a dividend yield of around 9.5%.
I have no reason to doubt these forecasts based on the information currently available. Both are generating a tremendous amount of cash from their operations, and have cash-rich balance sheets with no debt. On top of this, the demand for new houses in the UK is only increasing.
Both political parties are promising to increase home building across the UK if they’re elected into power next week. So, as long as there’s no dramatic change in the political environment over the next 12-months (or Labour decides to nationalise the homebuilding industry) I see no reason why these companies cannot meet the City’s income targets.
These dividend yields could be enough to help Taylor and Persimmon outperform the market in 2020 because, over the past decade, the FTSE 100 has produced an average annual total return of approximately 7%. However, I believe investors will also benefit from capital growth next year as well.
Undervalued
Political uncertainty has weighed on the share prices of home builders for the past few years. But as this uncertainty has started to lift, shares in both businesses have rallied.
Since the beginning of September, when Boris Johnson set out to finish the UK’s divorce from the EU, shares in Persimmon and Taylor have increased by 32% and 17% respectively, excluding dividends.
This suggests to me that if the Tories are elected back into power with a significant majority, these homebuilders could rally further. It’s difficult to tell what sort of market response this scenario would lead to but, according to my research, before the referendum in 2016, both were dealing at a mid-teens P/E multiple.
With their shares dealing at forward earnings multiples of 9.5 and 8.6 respectively, this suggests there could be a potential upside on offer for investors of more than 30% from the current levels.
When you add in the dividend income investors are set to receive over the next 12 months, it quickly becomes apparent these two companies have the potential to produce a return of around 40% for investors in 2020.
These are only back-of-an-envelope calculations, but I believe they clearly show how undervalued these companies are. That upside that could be on offer for investors as some degree of certainty eventually returns to the UK political scene.