Redrow: an attractive homebuilder

Row of houses © Redrow
Redrow is building on its recent success

Redrow stands to benefit from liberal planning laws and pressure to build more.

If you live in London, you know that the property market is much cooler than it was a few years ago. During the recent boom, sellers would find themselves besieged by buyers and would end up having to fight them off. However, depending on what house-price index you use, prices in the capital are either static or even falling.

By contrast, outside of the M25 the market seems to be in rude health. At the same time, there is an increasing acceptance, from both the government and the wider public, that more houses need to be built, even if this means allowing home construction on parts of the previously sacrosanct “green belt”.

This is good news for homebuilders such as Redrow (LSE: RDW). Redrow is one of Britain’s largest homebuilders and has been pursuing an aggressive programme of expansion designed to take advantage of both pent-up demand around the UK and more liberal planning laws. These involve the construction of various “Garden Villages” in the UK.

The idea is that instead of building a load of houses without any consideration for the community created, these are properly planned developments in fast-growing areas where people want to live. For example, Redrow is heavily involved in the Ebbsfleet Garden City in the Kent commuter belt. This is a new town and development, originally the brainchild of former chancellor George Osborne, which should eventually contain 15,000 houses. At last count, 901 houses had been built.

For the past few years Redrow’s strategy has paid off, with revenue tripling from £600m in 2012-2013 to an estimated £1.8bn in 2017-2018. While the rate of growth is expected to slow down over the next few years, the company is still expected to see double-digit growth for 2018 as a whole, while the housing shortage should provide fertile ground for future expansion. The expansion has not come at the expense of margins, which have actually increased. The homebuilder also continues to deploy its resources efficiently, and has produced returns on invested capital of around 15%-20% for each of the past four years.

Redrow also looks attractive in terms of valuation, since it trades at only 7.2 times forward earnings, and it has a solid dividend yield of 3.8% a year. Its is not excessively levered, with the £966m worth of debt less than the equity value of £1.24bn. This means that it is unlikely to face any major difficulties if interest rates end up rising faster than anticipated, or there is a UK-wide fall in housing prices. From a technical perspective, Redrow’s price is very close to the 52-week high and comfortably above the 100-day moving average.

Overall, I’m going to suggest that you take a long position in Redrow £3.50 per 1p (which is more than the IG Index minimum of £1 per 1p). I also suggest that you put a stop-loss of 463p. Given a starting price of 623p, this gives you a potential downside of £560.

Trading techniques… sentiment matters

The advance decline ratio is a popular trading technique related to sentiment. This compares the number of stocks that are rising during one day with the numbers that fall. So, if 66 stocks rise and 33 fall, then the ratio will be 2 (66/33). Similarly, if 33 rise and 66 fall then the ratio will be 0.5 (33/66). Because this reading can be very volatile, traders tend to take a moving average of a certain number of days (usually at least ten) in order to help smooth the data out.

Generally a high reading is considered bullish, and a sign that it is time to buy, while a low reading is considered to be bearish, and time to sell. The argument is that a market increase that is being reflected in the majority of stocks is broader, and therefore more sustainable, than one where the market is being dragged up by just a few outliers. As always, there are contrarian investors who argue the opposite, namely that a broad market increase is a sign that it is overbought and heading for a reversal.

A slightly more complicated version of the advance decline ratio is the advance decline line. This simply subtracts the number of stocks rising from the number declining. The resulting number is then taken cumulatively over a period of time. So, if 80 stocks rise and 20 fall on one day, the number would be 60. However, if only 60 rise and 40 fall on the next day, the advance/decline line would rise to 80. In this case, traders would be interested in the direction of the line, especially if it was behaving differently from the overall market. Several traders used this technique to anticipate the 1987 market crash, the biggest single-day drop in history.

How my tips have fared

This has been a pretty good fortnight for almost all parts of my portfolio. All four of my long positions have gone up. IG Group went up to 887p, which means that it is making a profit of £633. Petrobras has surged to $15.90, so it is now over £1,000 in the black. Greene King is now 468p, which works out at an overall profit of £468. Even Micron has gone up to $55.48, thanks to some good earnings figures. The total profits of all my long positions are £2,325, which is substantially more than the £1,621 they were making last time.

This good fortune has extended to my short positions as well. Despite Elon Musk promising another new model, the price of Tesla shares has fallen to $285. This is close to the $283 that I took out my short position at. After last month’s rally nearly forced me to cover the bitcoin short, the cryptocurrency has also fallen to $8,242.

The only black spot was the fact that the S&P 500 has gone up to 2,733, which means I’m losing £270 on a trade that I was slightly ahead on. But I’m still making a profit of £468 on my shorts, which is only £20 less than two weeks ago.

Overall, five of my seven open trades are making money, which works out to net profits of £2,793. Even when you take into account the losses that I’ve made on our closed positions, this still works out at £2,311. Given this success, I’m going to keep things as they are for now and not close anything out. However, I am going to raise the stop-losses on some of my long-standing positions, in order to ensure that I lock in some profits. So, the new stop-loss on IG Group, which is my longest-running trade, will be 745p (from 700p) and Petrobras will be $13 (from $12). I’m also raising the stop-loss on Greene King to 375p (from 345p).