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Persimmon’s (LSE: PSN) share price has dropped 28% from its 30 October one-year traded high of £16.62.
A significant drop in a stock’s price like this always captures my interest as a long-term investor. It may indicate a widening in the gap between its price and its value, which are not the same thing, of course (price is whatever the market will pay at any point for a share, but value reflects underlying business fundamentals).
In my experience, investors can make major long-term profits by capitalising on this gap. Conversely, this scale of price drop might signal that the underlying business itself is worth less than it was before.
To find out which is true here, I looked again at the core business and ran the key numbers.
How do the business fundamentals look?
The UK housing market has had a torrid time of it over the past few years. The Covid lockdowns that began in the first quarter of 2020 prevented people from viewing properties and halted house moves.
Meanwhile, quantitative easing to support the economy sparked inflation, pushing interest rates to 16-year highs by 2023. This kept housing demand low.
I believe a risk to the housing market is that the UK’s economic outlook remains uncertain in the short term. This view was highlighted by Persimmon in its most recent (H1) results, released on 13 August.
That said, the country’s second-largest builder recorded some good numbers over the period. New home completions rose 4% year on year to 4,605. And its new home average sales price increased 8% to £284,047. Total revenue jumped 14% to £1.5bn, while underlying operating profit climbed 13% to £172m.
Looking ahead, the firm reiterated its previous guidance for 11,000-11,500 homes built this year.
It forecast this would be achieved at an operating margin of 14.2%-14.5%, which should be a strong driver of profit growth. This compares to 13.1% in the same period last year, and surpassed analysts’ forecasts of 12.3%.
For 2026, it forecasts an increase to around 12,000 new home completions.
Analysts forecast that Persimmon’s earnings will increase by 15.1% a year to end-2027. And it is ultimately growth here that powers any firm’s share price and dividends higher over time.
So is there a price-to-valuation gap?
Such earnings growth is reflected in a company’s cash flow. And future cash flow forecasts are the basis of the discounted cash flow (DCF) valuation model.
It uses these to pinpoint the price at which any firm’s share price should trade. In Persimmon’s case, it shows the shares are a whopping 49% undervalued at their current £11.78 price. Therefore, their ‘fair value’ is £23.10.
As asset prices tend to converge to their fair value over time, this tells me a turnaround in Persimmon’s share price is due.
My investment view
That said, I am at the later stage of my investment cycle (aged over 50). This means I do not want to wait for any stock – or market – to recover from any shock.
I think one of these could come from an extended period of uncertainty around the UK economy. So this stock is not for me at my time in life.
However, for those at an earlier stage in their investment cycle, I think it well worth considering.
