Analysts forecasts and Persimmon

Why are stock market analysts forecasts so varied? Or to put it another way, why are they so useless as a reliable predictor of the future? This question came to mind when looking at their recommendations after Persimmon issued their final results on the 25th February.

Persimmon is of course a house building company. So it’s operating in a well established sector where business trends are well researched and well known. Indeed house prices are dinner table conversations and the level of new house building and mortgage approvals are well publicised. This should not be a sector like say technology where future sales are imponderable and profits (where there are any at all) are so dependent on so many variables that forecasting them accurately is impossible.

Persimmon’s results were incidentally much as expected, with both revenue and profits slightly better than forecast. But these were the prognostications from various analysts in the following week (source: InvestorEase):

Credit Suisse downgraded its rating to “neutral” and set a price target of 1486p.

Jefferies reiterated a “hold” rating with a price target of 1427p.

Citigroup reiterated a “buy” rating with a price target of 1610p.

Panmure Gordon reiterated a “sell” rating with a price target of 1218p.

Deutsche Bank reiterated a “hold” rating and set a price target of 1400p.

Barclays reiterated its “equal weight” rating with a price target of 1170p.

So that’s one “buy”, one “sell” with the rest neutral, but price targets ranging from 1170p to 1610p,  in other words 14% above the current price to 18% below. The share price at the time of writing is 1420p.

Some investors are surely going to be very disappointed by their portfolio performance if they used some of the individual guidance to buy Persimmon, or are alternatively likely to miss out on a great opportunity.

What conclusions should private investors draw from this analysis? Perhaps the following:

– It might be best to rely on the “wisdom of crowds” and look at the consensus forecasts for future earnings per share and dividends rather than individual broker forecasts. Then use those to decide what that might mean in terms of a future share price. For example, what are the comparable p/e ratios of similar companies in the same sector, and the historic multiples on which they have traded.  House building companies are not normally very highly rated because their profits tend to be cyclical, growth has been limited and the sector is vulnerable to Government policy interference (and not just on interest rates). Housebuilders are only now getting back to levels of revenues and profits seen five years ago, but future forecasts are very positive, with prospective p/e’s based on the current share price of 13.4 and 10.9 for the next two years. Dividend yield is relatively high and there is a “capital return programme” in place at this company so cash flow is also a factor investors take into account here.

– Use your own judgement to decide whether the forecasts make sense, and whether the competitive position of the company is strong. Also as with any company, performance is based on management ability and that is one reason why analysts often differ in their forecasts. Some of them simply may not like or trust the management. So take every opportunity to meet with the management, read what they have to say or listen to their presentations (many companies put results presentations on-line now for example – Persimmon’s final results presentation is available from here: http://corporate.persimmonhomes.com/investor.aspx including the Q&A session). As ShareSoc reiterates regularly, it’s also useful to go to Annual General Meetings, if you can, so as to learn more about the business and its management.

One reason why analysts forecasts differ is because they may be using different models to value companies. For example, building companies are both trading companies in that they are manufacturing and selling houses, but also have a considerable property element – both of constructed houses not sold and substantial undeveloped land banks. So as with any property company they can also be valued on an asset basis rather than an earnings basis. The relative emphasis of these factors may affect analysts views. So Persimmon is valued on 2.2 times net asset value by the market which is high relative to other housebuilders.

There is quite an extensive academic literature on the accuracy of analysts forecasts and the wisdom of their recommendations if you wish to research it. Analyst’s performance tends to be like fund managers performance – past performance is no indication nor guarantee of future performance as the standard investment health warning goes.

But at the end of the day, the value of any share is based on investors perceptions of how much they are willing to pay for future earnings and cash flow, and their confidence that the numbers will arrive. You as an investor have to make that decision so don’t rely on analysts prognostications because they could be all over the place and often are.

Roger Lawson

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