Assessing Value

Monday, 18th July 2016 10:34 - by David Harbage

Barratt Developments announced a trading update today, following on from reports in the past week from its industry peers Bovis and Persimmon, which has been carefully scrutinised for any indication of how potential buyers are responding to the prospect of Brexit. Following on from the previous blog entitled ‘Property: an Investment or Speculation’, and in response to requests from readers, this article seeks to answer the question of “Where in the sector does best value reside?” (if you’ll excuse the pun). The writer uses a spread sheet to monitor valuation and various inputs to that process which, incidentally, is far from complete but might be of interest to prospective investors.   

This spread sheet is populated with most of the prime pure London stock exchange listed home builders (excludes firms with significant contracting operations), showing data based on today’s close of business share prices and the consensus of brokers’ published opinion. As a consequence, the following can be incorporated into this assessment of relative value:

1. M.Cap represents market capitalisation, which is the total worth (based on the latest mid-price) of all the company’s equity or shares in issue.
2. Year end shows the company’s accounting year, as far out in the future upon which brokers will typically provide a forecast of profit, dividends etc.(normally 1 or 2 years).
3. EPS represents earnings per share for that future year (‘looking out to the horizon’), based on an average of the published profit forecasts made by brokers (see Broker View to see how many analysts are contributing). This figure can change rapidly, on weekly basis, as company news or wider circumstances develop,
4. PEG ratio compares the pace of the profit growth in that future year with the PE. A ratio of 1 implies average growth of say a company share on a PE multiple (or rating) of 10 and delivering 10% growth in EPS in that year; a sub 1 PEG indicates higher earnings growth than the PE might suggest, a PEG in excess of 1 indicates slower. Where no PEG ratio is displayed, this implies a fall – or static growth – in profits. Of course, the PEG ratio might be rendered less relevant if the intervening of current year’s growth has been exceptional and does not in itself indicate the direction or pace of future earnings.    
5. PE multiple (or ratio) compares the EPS of that future year to the current share price.
6. Target PE is the writer’s subjective view on a ‘fair valuation’, with higher ratings accorded to the more liquid FTSE100 stocks (attracts bigger investing institutions) and lower ones to the AIM listed constituents. Other views could be taken on the higher risk nature of certain firms, notably Berkeley’s upmarket London offering.
7. Fair Value is calculated by applying the Target PE (assessment of a fair multiple) to the consensus of broker opinion on future earnings (EPS).
8. Up/down side reflects the difference between the Fair Value and the current stock price.
9. Broker view details the number and various mixes of recommendations made by brokers (on the ‘sell side’ of the industry, as compared to ‘buy side’ fund managers’ opinions which are reflected in their equity ownership). Larger companies attract more broker interest (perhaps anticipating corporate fee-earning activity), while smaller companies are less well-researched, providing greater scope for surprise (both positive and negative). Broker recommendations are biased towards the positive, in anticipation of maintaining a good relationship with listed companies (i.e. research concluding in a Sell is rarer than what one might intuitively expect).

10.  Dividend Cover represents the number of times that a forecast dividend is ‘covered’ by earnings in the future year (mentioned in item 2 above, as the Year end). An EPS of 30 pence and a dividend of 10 pence for a given year would represent cover of 3x.

11.  Yield is the forecast dividend for the future year expressed as % income based on the current share price. 

As mentioned earlier, there are other considerations and data which should be borne in mind when making an assessment or judgement on an individual company share in this sector. For example the net asset value of the equity and the track record of the company. However some of these factors may be difficult to quantify (for example a subjective view of the current management) and where figures can be applied, they may be misleading (such as net asset value might reflect the acquisition cost of the land bank – which in itself might vary significantly in age, location or nature from the peer group – or perhaps the current value). The business model and the track record (both in operational and financial/balance sheet terms) might also vary dramatically. Besides differing on location of their sites, the mix of the properties (private, affordable housing, mixed use schemes) built or the end customer (first time buyer, family, apartment), individual companies will put greater emphasis on different financial targets. As regards the latter for instance, Barratt Developments put a priority on return on capital employed (ROCE) or invested capital (ROIC) which prompts them to turn over their assets more quickly than some, and is evidenced by a relatively short bank of consented (planning permission granted) land.

Track record can be assessed in different ways, but often a clear strategy can be seen over a number of years – probably extending beyond a particular chief executive’s tenure to a decade or more. In the 6 July blog, Persimmon and Berkeley Group were highlighted; while differing significantly in location of their land and end proposition, both companies have  maintained a strong balance sheet (low or no debt), a longer than average land bank and a longstanding board of directors. When the domestic housing market has weakened in the past, the management of both of these companies have been quick to respond (by reference to their land replenishment in particular).