I have a warm affection for housebuilders. This is unusual among value investors, who (if the blogs I read and the people I talk to are anything to go by) typically tend to see them as horribly cyclical, commoditised land banks run by executives with an uncanny knack for leveraging into recessions and mis-timing the market. There is certainly some truth in this.
I’d probably hate them too, if it wasn’t for the good they’ve done me. My first ever investment was in Barratt Developments in the depths of the recession when, armed with only a notebook of valuation metrics and the sort of blind confidence only a true rookie could muster, I stuck the vast majority of my (admittedly meagre!) savings on the beleaguered builder. Sure enough, it was a blow-out bet, and probably has a small part in me being here today. Had the coinflip come up tails, I’d probably have quit and become a dentist. I’m thankful for my early fortune - ‘Expecting Dentures’ doesn’t have quite the same ring to it.
But let me lay out the discussion in this post. This is that, in my eyes, housebuilding is one of the few sectors the market understands well. It values housebuilders in a way fairly consistent with what I’ve highlighted in the first paragraph above. How is this? Typically, it is on a book value basis. A book value basis makes sense in a commoditised industry where your biggest input is capital; because the capital you employ in your operations will be the best guide to how much profit you make. It is difficult to see how any one player could earn a supernormal return on capital – the biggest chunk of your cost base (land) is subject to intense competition from other builders, and the margins on your finished project are inherently constrained by the availability of other houses nearby… which is doubtless the basis on which the acquired land was priced. Consider that Bovis called the biggest challenge in 2014 ‘the availability and cost of subcontract labour’. This bears all the hallmarks of a commoditised sector, where the economic profits flow through to the inputs.