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Why I’m still avoiding these 3 popular FTSE 100 stocks

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The UK’s volume housebuilders are popular FTSE 100 stocks at the moment. The majority of City brokers and my fellow Motley Fool writers are in agreement. Barratt Developments (LSE: BDEV), Persimmon (LSE: PSN) and Taylor Wimpey (LSE: TW) have considerable investment appeal.

By contrast, I’ve been bearish on the three stocks for some time. Here, I’ll discuss why I’m still avoiding them. I’ll also look at the bull case. This could potentially see me missing out on some handsome returns.

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Rewarding FTSE 100 stocks to own?

The table below shows the aggregate view of City brokers on the housebuilders. I’ve collated it from the individual BDEV, PSN and TW pages on the financial data website ShareCast.

What the brokers say

Number of brokers

Strong Buy

44

Buy

2

Neutral

10

Sell

1

Strong Sell

0

As you can see, the majority of brokers are extremely positive, and there’s only one dissenting voice on the negative side.

It’s a similar story among Motley Fool writers. For example, my colleague Jonathan Smith titled an article last month: ‘If I could only invest in 1 FTSE 100 stock for 2021, this would be it’! The stock in question was Barratt Developments.

There are some strong positives to the bull case. The current stamp duty holiday on homes worth under £500,000 is a short-term boon. More importantly, bulls point to a structural imbalance between supply and demand, and record low interest rates that are expected to persist for some time.

I think it’s certainly possible a homes shortage and favourable lending conditions could underpin housebuilders’ sales and profits well into the future. And if so, BDEV, PSN and TW are likely to be rewarding FTSE 100 stocks to own. However…

Valuation fundamentals

I turned from bullish to bearish on housebuilders in autumn 2017. This was on the basis that housebuilding is a highly cyclical boom-and-bust industry. And that builders’ operating margins and price-to-book (P/B) valuations had reached cyclically high levels — indeed, unprecedented highs.

In last spring’s market crash, the P/Bs of the big FTSE 100 housebuilding stocks never got low enough for them to make my buy list. I look for a sub-1 P/B, and FTSE 250 stock McCarthy & Stone, on a rating of 0.5, was my pick of the sector.

The table below shows the P/Bs of BDEV, PSN and TW last spring and today.

 

Last spring

Today

BDEV

1.1

1.6

PSN

1.9

2.7

TW

1.2

1.6

The three FTSE 100 builders’ P/Bs are getting back towards their historical top-of-the-cycle levels. I don’t see sufficient upside for their shares from here — unless their P/Bs were to rise to new unprecedented highs.

I concede this could happen. The asset-value-inflating distortions stimulated by years of low interest rates and money printing, plus what I think of as the crack-cocaine stimulus for housebuilders called Help to Buy, could encourage investors to push up the P/Bs of housebuilding stocks beyond the established historical range.

However, my investing is driven by valuation fundamentals. Not by fear of missing out on what I reckon would be risky ephemeral gains from unsustainable government interventions in the free market. As such, BDEV, PSN and TW are FTSE 100 stocks I’m continuing to avoid.

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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.