Change of Tack
Barratt are one of the shares that have been with me the whole last year and a half since I formed the portfolio. While my approach has changed – clearly vastly for the better – they’re one I’ve stuck with, and even bought more on their significant dip a little way in. My original premise was completely oversimplified but I still think there’s merit in it; essentially, I bought because it was trading at something like 35% of book value. Something I gave nowhere near enough credit to at the time was how book value was actually calculated. It sounds obvious, but as a rookie I put too much faith in the financial statements – something that had me come a cropper in other investments later on.
As safe as houses
The fact is, the valuation of inventory, work in progress, land with development potential etc. isn’t quite as black and white or clear cut as I first assumed. Given the huge amount of impaired land Barratt had on their books, this is fairly critical. Even impaired land though, assuming it’s been impaired ‘perfectly’ to its recoverable value, is nothing like similar to un-impaired land; impaired land sits on books at recoverable amount. You only have to look at the margins the company earns on land bought and impaired at different timings to see how the total carrying value has read-through problems to future cashflows. There are a lot of other bits of information to need to really know the true economic value beyond that one figure.
This is something I vastly underestimated – and didn’t particularly understand. Frankly, the exact accounting still isn’t something I’m hugely comfortable with. I’m getting better; such is the value of writing and practicing – but it means I should treat my own judgements with a large dose of skepticism. Hopefully this comes through in most of my posts; rarely am I hugely confident. It is a balancing of odds, or an attempt to do so.
Where we stand now
With Barratt now, then, we’ve passed the point where my original investment idea becomes irrelevant – we’re now a bit over tangible book value, instead of 40% thereof. That means it’s been a big success for the portfolio – I bought at about 116p, topped up at 80p, and we currently sit at 230p, but it also means I should consider selling. The question I then have to ask myself is this – given that my first investment theory was a touch naive, what is my best appraisal of the stock’s value now?
The reason it’s difficult is the same reason it’s always been difficult – the cyclicality. Housebuilding is the definition of a boom and bust industry. I suspect that’s what makes it relatively good value when everything looks dire, and terrible value when things are good – in reality, the good times are always too good and unsustainable, and the bad times are equally unsustainable. Houses are still very much needed, indeed in far excess of what has been built in the last few years.
It’s all in the hocus-pocus
Essentially the difficulty with Barratt is now deciding what value to assign the ‘entity’ – the intangibles that go beyond the value of just the stock and the balance sheet. What power does Barratt have, as a brand and as an organisation, to earn returns about its cost of capital? We probably have to attribute it some given simply its size. Housebuilding isn’t really a small player’s game. There are scale efficiencies that are exploitable by the big firms. Pre-crisis Barratt hit a P/TBV of closer to 2 – far removed from the recent valuation of it at significantly less than the stock on its balance sheet. That was, in hindsight, clearly an inflated value, but it’s obvious that even then there was cyclicality priced in. Barratt never traded at an ‘expensive’ P/E. Clearly there was at least some recognition of the risk of a flop, though probably not enough.
Finally, though, I should probably point to a slightly more contentious reason why Barratt could still be undervalued. Contentious, I should note, because discussions on the price of housing seem to spark a level of vitriol between the sides that’s pretty rare to find – except perhaps in the case of gold. Either way, if the housing bulls are right – a side I edge towards – we’ve had a few years of undersupply in an industry that was never really oversupplied in the first place. Personally, I suspect government planning regulations are an inherent and hugely powerful distortion on a market that’d otherwise be building a lot more homes, particularly in the south. My default position, then, is that there’s more upward potential (rules get slackened) than downward potential there. Houses are prohibitively expensive in the UK.
That sort of hints at another bonus in being a big housebuilder, I guess – you need capital and you need knowledge to navigate the maze of planning restrictions, to keep the banks of cheaper ‘strategic land’ and so on.
I don’t delude myself that it’s a particularly ‘stockpicking’ type decision, which is why I’m a little torn with the online portfolio – I want this to be about stockpicking, not about my long-term macroeconomic and political guesswork – if you’ll permit me to construct straight lines in a blurry world. I’ll probably continue to sell down and trim my position to something much smaller than where it currently stands. A bit of extra disclosure, though – Barratt were the first stock on the blog I ever bought in real life, and I suspect I’ll continue to hold at least a little bit there, too. Partly for the reasons above, and partly because it’s a neat hedge given that I don’t own a house yet. Imperfect, I suppose, but intellectually attractive!