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OPINION

Time to start building once more?

Time to start building once more?
December 7, 2015
Time to start building once more?

I first discovered the phenomenon while carrying out quantitative research more than a decade ago ('Time to take stock', 14 Nov 2003). At the time I noted: "On average, you would have made a healthy 8.1 per cent profit over the first three months of the year by investing in the housebuilding sector...and anyone possessing the Midas touch by calling the top in each of those first quarters would have made an average three-month return of 15.7 per cent since 1992." I also highlighted that the strategy was relatively low risk, because "only two of the 12 years have produced negative returns".

I identified several specific factors to explain why this phenomenon occurs. "The main one is the reporting season for housebuilders, which starts during late February and early March. As a result, we are guaranteed newsflow from the leading players (and generally positive news at that) and, more importantly, the market focuses on the companies' outlook statements. Combine this with general media attention on the spring housing market (this is the time of year most of us prefer to move house), and we have all the ingredients in place for a re-rating."

 

Table 1: FTSE 350 Housebuilders' first-quarter performance since 1980

YearHousebuilding sector quarterly return (%)FTSE All-Share quarterly return (%)Outperformance (%)
19806.64.62.0
198153.56.047.5
198218.04.313.7
198315.97.88.1
19844.911.4-6.5
1985-10.73.9-14.6
198630.118.711.4
198725.620.25.4
198810.93.07.9
198916.816.10.7
1990-7.0-7.40.4
199118.615.63.0
19927.5-1.48.9
199313.33.210.1
1994-4.0-7.13.1
19952.71.11.6
19965.12.22.9
19975.94.31.6
199821.515.46.1
199934.58.326.2
2000-16.2-4.1-12.1
200114.8-9.123.9
200212.01.310.7
20030.4-8.38.7
200419.0-0.519.5
20058.11.76.4
20068.37.11.2
20070.11.9-1.8
2008-6.5-10.94.4
200916.4-10.226.6
20100.52.8-3.3
201112.70.810.9
201224.73.321.4
201324.79.315.4
2014*12.80.612.2
2015*18.92.016.9
Quarterly return11.43.38.1
Up years 312731
Down years595
*Simon Thompson advised buying the sector early on 26 November 2013, so performance period is 18 weeks to 31 March 2014. He advised the same trade on 25 November 2014, so performance period is 18 weeks to 31 March 2015.

 

However, once a trading pattern establishes itself, the profits made from following the trend can be quickly arbitraged away as more and more market participants become aware of it. It is therefore worth noting that the factors I identified driving the sector returns all those years ago are the same ones at work today. Moreover, if anything the trend has become stronger, rather than weaker, even though more investors are aware of the bumper gains to be made. In fact, in the past decade you would have only lost money once by following this investment strategy and the average quarterly return of 11.3 per cent has beaten that of the FTSE All-Share index by a country mile. And in the past five years, you would have made an average return of 18.8 per cent, an eye-watering gain that any investor would be delighted with.

To put this into some perspective, if an investor had purchased shares in the home builders in the first quarter of 2004; taken profits at the end of March; put the cash under the mattress for the rest of year; and then repeated the process all over again the following 11 years; then a modest investment of £10,000 in 2004 would now be worth over £35,850. So why does this trading strategy work so well?

Firstly, housebuilding is a highly-seasonal business with newsflow and sales firmly skewed towards the all-important spring selling season. So at this time of year there is greater interest in the sector as investors focus on price trends and the strength of the underlying housing market. As companies have a firm bias towards reporting financial results in the first quarter - the majority have calendar or June year-ends - then this brings into focus the merits of the housebuilders as an investment.

There is also another reason why the sector outperforms the general market in the first quarter: this time of the year is when investing in 'cyclical' or 'value' stocks - namely, those that are very sensitive to changes in macroeconomic conditions - does incredibly well.

 

Déjà vu?

And this year is unlikely to be any different because the sector is still enjoying relatively benign conditions: mortgage rates are at multi-year lows; financial markets are pricing in the first rise in Bank of England base rate not until November next year, so low mortgage rates will be with us for longer; and housebuilders' profits continue to reap the benefit from cheap land acquired during the depths of the recession. Demand in the housing market is also being underpinned by a raft of government initiatives, record employment levels in the UK and net migration running massively above the government target. At the same time there is a massive skill shortage to boost output to anything like the level needed to put supply and demand into equilibrium.

There is a further reason why I am positive: a likely surge in buy-to-let purchases in the first quarter as investors try to beat the new stamp duty rate regime for second homes and residential investment property. I also feel that equity investors in housebuilders who have been fretting about the likely impact of the Chancellor's tax changes on buy-to-let sales and the market in general are missing an important point here: namely, corporate structures with more than 15 properties are exempt from the higher duties, and incorporation allows landlords to also avoid the cuts to tax relief on mortgage interest unveiled by the Chancellor earlier this year. In fact, there is already clear evidence that professional landlords are ahead of the game as lending data from Kent Reliance shows that mortgage applications made through a limited company structure trebled in September on the same month a year earlier. Buy-to-let investing may be made more difficult for small landlords, but reports of its death have been greatly exaggerated.

Of course, shares in the homebuilders have been on a tear for the past six years, so investors are hardly ignoring the fact that they have been making hay. However, I feel that this good news story has yet to run its full course with shares in the nine FTSE 350 homebuilders trading on an average forward PE ratio of 11.6, offering a prospective dividend yield of 4.3 per cent (including special payouts), and rated on 2.26 times book value.

 

Table 2: FTSE 350 Housebuilders' key financial data

CompanyPrice (p)Mkt cap (£bn)Share price gain in 2015 (%)Price-to-book valueProspective dividend yield (%)Forward PE ratioYear-end
Barratt 6156.230.31.654.911.9Jun 2016
Bellway2,6163.234.62.033.49.6Jul 2016
Berkeley3,6014.945.23.015.614.2Apr 2016
Bovis9981.312.21.504.010.1Dec 2015
Crest Nicholson5561.442.42.503.511.8Oct 2015
Galliford Try1,4881.214.72.155.411.3Jun 2016
Persimmon1,9756.123.22.805.012.7Dec 2015
Redrow4581.754.41.992.09.1Jun 2016
Taylor Wimpey199.56.444.32.704.913.4Dec 2015

 

It's also reassuring that share prices of the homebuilders sold off sharply in late summer when the market took a tumble on the potential fallout from the Chinese slowdown, having rallied strongly all year. This is part and parcel of bull markets and it's not something I am overly concerned about. In fact, I positively embrace the timing of the sell-off - prices are still off 10 per cent from their summer and early autumn highs - as it has set up the perfect backdrop for my favourite first quarter rally to take place once again.

 

Jumping the gun

In fact, I recommend jumping the gun and buying shares in the nine FTSE 350 housebuilders now as I have a strong feeling other investors may well have come to the same conclusion by the new year, so there is little point delaying. The companies are: Barratt Developments (BDEV), Bellway (BWY), Berkeley (BKG), Bovis (BVS), Crest Nicholson (CRST), Galliford Try (GFRD), Redrow (RDW), Persimmon (PSN) and Taylor Wimpey (TW.).

This same strategy worked a treat in the autumn of 2013 and 2014 when I recommended buying into the sector at the end of November. Shares in the FTSE 350 housebuilders subsequently rallied on average by 12.9 per cent and 18.9 per cent, respectively, in the following 18 weeks, in a lacklustre market. Please note that I advised taking some profits in early March this year to crystallise what proved to be hefty short-term gains.

 

Table 3: FTSE 350 Housebuilders price performance (25 November 2014 to 31 March 2015)

CompanyPrice on 24 Nov 2014 (p)Latest price on 31 Mar 2015 (p)Share price gain (%)
Redrow27036033.5%
Galliford Try1,1511,51531.6%
Crest Nicholson35644023.6%
Taylor Wimpey13015519.2%
Bovis83298218.0%
Barratt Developments45052817.3%
Persimmon1,4951,66311.2%
Bellway1,8291,9818.3%
Berkeley 2,4592,6397.3%
Average18.9%
FTSE All-Share3,5913,6632.0%
Outperformance16.9%

*Simon Thompson advised banking gains on 5 March 2015 in shares of Bovis, Crest Nicholson, Redrow, Galliford Try and the share price on these dates are used in the above table.

 

Table 4: FTSE 350 Homebuilders price performance (26 November 2013 to 31 March 2014)

CompanyPrice on 26 Nov 2013 (p)Latest price on 31 Mar 2014 (p)Share price gain (%)
Barratt Developments339412.521.7%
Galliford Try1,120132718.5%
Redrow27932616.8%
Bovis80589511.2%
Bellway1,4941,66011.1%
Crest Nicholson35439311.0%
Berkeley2,3892,6209.7%
Persimmon1,2281,3469.6%
Taylor Wimpey1121185.4%
Average  12.8%
FTSE All-Share3,5623,5840.6%
Outperformance12.2%

  

Of course, no trade is guaranteed to produce a profit every time and it's only fair that I flag up that the FTSE 350 housebuilders have seen their share prices rise by almost a third on average in 2015. This could make them more susceptible to general market weakness if another growth scare emerges as it did in the summer. But it's also worth noting that only once (in 2000) in the last 35 years has the housebuilders' index fallen more than the UK market when equities ended the first quarter in negative territory. On the other eight occasions when the UK market fell in the first quarter, the housebuilders outperformed the index by an average of 11.9 per cent. In other words, it's pretty rare to see this sub-sector underperform in this specific three-month period when the general market falls. Furthermore, when the market rises, we can expect absolute outperformance as our history books show.

So with the housebuilders set to report bumper results, robust order books, strong cash generation and hefty dividend hikes, then I feel there is potential for the sector to rally yet again between now and the end of March and would advise buying shares in all nine now to play the trade.

Finally, there have been a number of announcements from companies on my watchlist including: Urban&Civic (UANC), Sutton Harbour (SUH), Sanderson Group (SND), 600 Group (SIXH), Amino Technologies (AMO), GLI Finance (GLIF), Burford Capital (BUR), Non-Standard Finance (NSF), Arbuthnot Banking Group (ARBB), Renewable Energy Generation (WIND), Dart Group (DTG), Grainger (GRI) and Creston (CRE). I intend updating my views on all these companies in the near future.

Please note that for a limited period of time, my book Stock Picking for Profit is being offered for sale at a promotional price of £11.99 plus postage, subject to availability, full details enclosed below.

  

MORE FROM SIMON THOMPSON...

I have published articles on the following companies since the start of last week:

First Property: Run profits at 47.5p ('Investing for bumper gains', 30 Nov 2015)

Paragon: Run profits at 384p; Redde: Run profits at 174p; Fairpoint: Run profits at 175p ('Capitalising on investor overreactions', 1 Dec 2015)

LMS Capital: Tender your pro-rata allocation ('LMS tender on the money', 1 Dec 2015)

Vertu Motors: Buy at 78p, new target range of 85p to 90p ('In the fast lane', 2 Dec 2015)

MS International: Run profits at 210p, target bull market high of 240p ('Engineered recovery', 2 Dec 2015)

Mountview Estates: Buy at 11,500p ('Mountview's accounts reveal hidden value', 2 Dec 2015)

Character: Buy at 485p, new target 600p ('Playtime for a popular Character', 2 Dec 2015)

 

■ For a limited period and strictly subject to stock availability, Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com at a special promotional price of £11.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: 'Secrets to successful stockpicking'