Buying shares in a company that has just released a profit warning is risky. After all, there is always a good reason behind a profit warning, and the issues which caused it could continue. As such, there is a good chance of paper losses in the short term, and even larger losses in the long run. However, such opportunities can also lead to high returns, too. A company that fell 10% on Monday morning after a profit warning could fall into the latter category, and may be worth buying for the long run.
A difficult year
The company in question is Bovis Homes(LSE: BVS). The housebuilder has reported a disappointing set of results for 2016 which show that its strategy has not performed well. It has led to a fall in pretax profit of 3% and, perhaps more worryingly, a high level of customer service issues. In fact, such is the gravity of the situation that Bovis has set aside £7m in customer care costs as it seeks to satisfy customers who are unhappy with the houses they have purchased.
The company will also seek to improve its production process and will conduct a strategic and structural review to ensure it delivers the highest possible returns from its land assets. Therefore, there does not seem to be a quick fix, and the outlook for 2017 has been negatively affected. Bovis now expects 2017's performance to be lower than previous guidance, which realistically means a further fall in earnings in the current year. This could cause investor sentiment to come under pressure beyond today.
Even though Bovis could endure a difficult year, its valuation may now take this into account. In the last five years its price-to-earnings (P/E) ratio has averaged 13.5. Today, its P/E ratio stands at just 8.4. Even if its bottom line falls in 2017 and 2018, there seems to be scope for a major upward rerating over the medium term. And since Bovis trades on a price-to-book (P/B) ratio of just 1, now could be the right time to buy it.
A better buy?
Despite this, its valuation is higher than that of sector peer Berkeley Group(LSE: BKG). It trades on a P/E ratio of 7.1, but is due to report major falls in its bottom line over the next two years. In fact, using its forecast earnings for 2019 puts Berkeley on a P/E ratio of 9.1. This indicates that the company remains a sound investment for the long term, especially since weak sterling may entice foreign buyers to the London property market. And since Brexit negotiations will be completed in around two years' time, the outlook for prime UK property may become more favourable.
However, given its lower valuation and potential for a turnaround, Bovis seems to be the better buy at the present time in my opinion. Its shares may fall further in the short run, but they could beat the FTSE 100 between now and the end of 2018.
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Peter Stephens owns shares of Bovis Homes Group. The Motley Fool UK has recommended Berkeley Group Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.