Seeking alpha among the housebuilders

True, at some point you have to make the difficult decision as to whether the best of the gains have been made and whether the risk:reward balance continues to favour holding a particular investment. This task is easier said than done because you also have to decide if there is a better investment out there more worthy of your capital. There is also a psychological element to investing too, because when investments have racked up substantial paper gains there is always the temptation to bank profits even though the investment case remains intact.

And this is precisely the position I find myself in right now as we are all sitting on some significant paper profits on the eight FTSE 250 homebuilders I advised buying at the start of the year ('Foundations of a rally', 10 Dec 2012). In fact, if you had bought at the opening prices on Wednesday 2 January 2013 as I had advised, you are now showing an average gain of 7.8 per cent on these eight holdings calculated on an offer-to-bid basis. That compares favourably with the 6.7 per cent return on the benchmark FTSE All-Share index and means the sector has outperformed the market by 1.1 per cent since the start of the year.

Homebuilders first quarter outperformance

To put this into some perspective, since 1980 the sector has risen by an average of 11.1 per cent in the first quarter of those 33 years - which represents a massive 7.7 points of outperformance above the 3.3 per cent return on the FTSE All-Share in the same three-month period. Past performance is generally no guide to future success, but bear in mind that the 20 times when the homebuilders have produced a return of 7.5 per cent or over in the first quarter, not once has the FTSE All-Share beaten the sector in that period. Moreover, the average outperformance by the housebuilders has been 13.5 per cent over the three months in those 20 years and, in no fewer than 11 years, the 'alpha' created was over 10 per cent. Only once in those 20 years, in 1989, has the 'alpha' been less than the current 1.1 per cent outperformance and in that year the sector then went on to rise more than 16 per cent in the three-month period so the trade proved fantastically profitable.

FTSE 350 Housebuilders' performance table in 2013

That in itself is a pretty compelling reason to stay long of all eight of the housebuilders and run your profits to create the 'alpha' this trade has historically made in the three months. But it is not the only reason to remain bullish because 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 increased interest in the sector as investors focus on price trends and the strength of the underlying housing market. And as companies have a firm bias towards reporting financial results in the first quarter - since the majority have calendar or January year-ends - this also brings into focus the merits of the housebuilders and creates interest among investors.

There is also another explanation why the sector can be expected to outperform the general market in the first quarter: this time of the year is when investing in 'cyclical' or 'value' stocks - ie, those that are very sensitive to changes in macroeconomic conditions - does well. Moreover, with mortgage rates at multi-year lows and housebuilders' profits getting a lift from cheap land acquired during the depths of the recession, the sector is enjoying relatively benign conditions at the moment.

Tailwinds propelling share prices

As I pointed out in my recent article on northern-England-based player Bellway (BWY) ('Profit from the London property boom', 30 January 2013), with the tailwind of the government's New Buy initiatives breathing life into the first-time buyer market and the Bank of England's Funding for Lending scheme offering a cheap line of credit to banks and building societies for up to four years, not only is mortgage availability improving, but lending costs have been trending down. Equally positive for the sector is the fact that the large players replenished land banks when it was cheap after the housing market went into reverse five years ago. As a result, the combination of low-cost land and rising property prices in the more prosperous parts of the UK are driving operating margins up sharply. These positive drivers were evident for all to see in Bellway's trading update to the market last week, news of which pushed the shares up 5.8 per cent from 1,101p, my trading buy-in price at the end of January in that aforementioned article, to around 1,158p. I am maintaining my price target of 1,250p on Bellway shares, which if met means there is another 8 per cent potential upside on the table between now and the end of March.

Moreover, with strong tailwinds underpinning the operational performances of all eight of the FTSE 250 companies, it is only reasonable to expect a further constant stream of positive newsflow between now and the end of March as all eight companies release further trading updates and financial results. In the circumstances, I have no hesitation in repeating my positive stance on the sector, at least until the end of the first quarter. Therefore, my advice is to run your profits as there could potentially be another 10 per cent of 'alpha' on this trade. Now is not the time to jump off the escalator.

■ Please note that I have released another two online articles today - A share set to hit the jackpot and A highly profitable arbitrage play, both of which are available on my homepage. I will also be releasing another online exclusive on Tuesday morning. Finally, I will be taking a four-week break during April to complete a book on 'Profitable stockpicking', my follow up to Trading Secrets: 20 Hard and Fast Rules to Help You Beat the Stock Market. The book will be published in early summer.

MORE FROM SIMON THOMPSON ONLINE...

Since the start of this year I have written no fewer than 27 online articles, all of which are available on my homepage. These include articles on the following companies or investment strategies:

Marwyn Value Investors (A highly profitable arbitrage play, 11 February 2013)

Netplay TV (A share set to hit the jackpot, 11 February 2013)

Oakley Capital, Randall & Quilter, Inland, Terrace Hill, Heritage Oil, Cairn Energy, Polo Resources, Trifast, Noble Investments, Fairpoint (Bargain Shares for 2013, 8 February 2013)

Telford Homes, MJ Gleeson, Stanley Gibbons, Molins, Indigovision, Trading Emissions, Mallett, Bloomsbury Publishing, Rugby Estates, Eurovestech (How the 2012 Bargain Shares fared, 8 February 2013)

Future (Decision time after a bright start, 5 February 2013)

Sanderson (An 'app' online investment, 5 February 2013)

Aurora Russia ('Time to play Russian Roulette', 4 Feb 2013)

BP Marsh & Partners ('Hyper value gains', 31 Jan 2013)

Bellway ('Profit from the London property boom', 30 Jan 2013)

Telford Homes, MJ Gleeson, Mallett, Rugby Estates ('Taking profits after a winning streak', 28 Jan 2013)

Market timing ('Lessons to learn', 24 Jan 2013)

Communisis, Netcall ('Bumper trading gains', 23 Jan 2013)

Crystal Amber, API, Sutton Harbour ('More upside to come', 22 Jan 2013)

PV Crystalox Solar ('Seeing the light', 21 Jan 2013)

Bloomsbury Publishing ('A publisher for the digital age', 18 Jan 2013)

Housebuilders first-quarter effect and performance table on all my recommendations from the final quarter of 2012 ('Stockpicking Marvels, 16 Jan 2013)

Eros ('A share firmly in the picture', 15 Jan 2013)

Netcall ('Jumping the gun: take two', 15 Jan 2013)

Moss Bros, Communisis ('Jumping the gun', 14 Jan 2013)

Stanley Gibbons, MJ Gleeson, Spark Ventures ('Small cap wonders', 11 Jan 2013)

IQE, Trading Emissions ('A tech share worth buying now', 10 Jan 2013)

S&P 500 portfolio of dog shares ('Dog shares barking back', 8 Jan 2013)

Air Partner ('A share ready to take off', 7 Jan 2012)

FTSE 100 traded options strategy ('Highly profitable options', 3 Jan 2012)

Telford Homes, MJ Gleeson, Molins, Noble Investments ('Rampant bargain shares', 31 Dec 2012)