Cheap shares: is Persimmon worth the risk?

Investors always keep their eyes open for cheap stocks. I certainly am. But are stocks ‘cheap’? I don’t mean that the shares are just cheaper than they were last year, I’m talking about meaningfully undervalued companies.

One of the stocks that has been depleted in the past year is persimmon (LSE: PSN). Homebuilders are down 42% in 12 months. So is persimmon cheap for a reason, or is it undervalued?

Did you fall?

Last year wasn’t a bad one for home builders. Home prices have risen and volumes are close to pre-pandemic levels. In the first half, the average selling price for new homes built by the company rose by £9,400 a year, to almost £246,000.

However, the macroeconomic environment has clearly changed, and higher interest rates have dampened property demand. Building cost inflation is also running around 5%. These factors result in a less than optimal environment.

Things got worse for investors at the end of 2022 when the company announced “ordinary dividends will be set at a level that is also guaranteed by post-tax profits“. This means that a large yield of 18% will be cut. It is not surprising but not positive news. The next dividend payment on the 2022 shares has been announced in March 2020.

And, as a shareholder, I’m a bit frustrated by Persimmon’s inaccurate estimates of fire safety promises. By the start of 2022, Persimmon said the pledge – the cost of refilling homes deemed unsafe after the Grenfell disaster – would be worth £75m. However, a few months ago it raised its forecast to £350m – about 40% of pre-tax profits in 2021/2022. I feel lost.

Are things getting better?

The company recently said that forward sales had fallen by more than a third as customers put off major buying decisions. Reasons include the end of the Help to Buy scheme, little sign that interest rates will fall before H2, and the cost of living crisis.

From a macroeconomic point of view, the situation is still not positive, although some analysts suggest that there will be no recession now. Inflation data is key to this. With double inflation, the Bank of England needs to keep rates high. And some analysts see the rate falling ahead of H2.

The stock has traditionally traded at a premium against its peers. There are several reasons for this. For one, Persimmon has previously achieved higher gross profit in the land bank, and has subsequently produced better results.

However, investors will need more confidence that this premium is worth it before the share price rises. Much of what we’ve learned about companies over the past decade appears to be unwritten. And the fire safety debacle has likely challenged investor confidence.

Regarding valuation, Persimmon’s forward price-to-earnings ratio is 8.43. That is obviously quite attractive. But I’m a little concerned that it might be a little too optimistic.

I kept my power dry on this one. I already have a stock of Persimmon, but now I refuse to buy any more. Uncertainty is a major factor here and I cannot accurately assess whether it is undervalued or not.