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It's been a mixed bag for the homebuilder for years Persimmon (LSE: PSN). Revenue and profit last year were the lowest in many years. The dividend per share was about a quarter of what it was a few years ago. It is not surprising then that the price of Persimmon has dropped by 20% in the last five years.
In fact, the decline was worse than that until recently. But the share has been rallying easily and moving higher 30% from the beginning of May.
With the housing sector sounding much better than it has for a while, would stocks still be a cheap addition to my portfolio even after the jump?
Opportunities for demand growth
Bullishness is easy to understand.
Due to the housing shortage in the UK, there has long been an opportunity to build more new homes. That has moved up the political agenda this year. Combined with a more attractive interest rate outlook than we've seen elsewhere in the last few years, that could help boost demand.
Standing on the supply side, Persimmon can benefit. It is a historically well-run business among the most profitable listed homebuilders.
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That is not by accident, but rather by design.
Persimmon has been an innovator in its field and has a well integrated business model. It wants to increase its financial return on building and selling houses, as well as providing efficiency to the business. With the prospect of a strong housing market in the coming years, that model is set to prove its worth once again.
Room for further growth possible
How well can the company do?
It currently trades at a price-to-earnings (P/E) ratio of 21. I see that as high in a cyclical and sometimes highly unpredictable market like home construction.
Then again, if the business can match its strongest underlying earnings per share from recent years as well, the potential P/E ratio is only about seven. If the housing boom means it does even better, that expected valuation could be even cheaper.
Furthermore, if the business is doing well, I expect the dividend to grow. Historically, Persimmon was an open dividend payer. Although it cut its profits several years ago, that seemed wise to me as the salary went down.
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If profits rise again in the future, as I think they will, I expect the board to revisit the dividend level and I would not be surprised to see a meaningful increase.
Chances of a further rise in the share price
Given the improving business environment and what that could mean for earnings – basic earnings per share in the first quarter were already slightly higher than the same period last year – I see scope for Persimmon's share price to continue to grow from here.
However, I continue to see a risk as it is unclear whether the political will to stockpile housing translates into a larger Persimmon culture.
The weak economy continues to cast a shadow over the housing market, so I currently do not plan to buy Persimmon shares in my portfolio.
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