Shareholders of LGI Homes would probably like to forget the past six months even happened. The stock dropped 38.1% and now trades at $57.05. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.
Is now the time to buy LGI Homes, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think LGI Homes Will Underperform?
Even though the stock has become cheaper, we don't have much confidence in LGI Homes. Here are three reasons why we avoid LGIH and a stock we'd rather own.
1. Backlog Is Unchanged, Sales Pipeline Stalls
Investors interested in Home Builders companies should track backlog in addition to reported revenue. This metric shows the value of outstanding orders that have not yet been executed or delivered, giving visibility into LGI Homes’s future revenue streams.
Over the last two years, LGI Homes failed to grow its backlog, which came in at $406.2 million in the latest quarter. This performance was underwhelming and shows the company faced challenges in winning new orders. It also suggests there may be increasing competition or market saturation.
2. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, LGI Homes’s ROIC has unfortunately decreased significantly. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
LGI Homes burned through $177.5 million of cash over the last year, and its debt exceeds the cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the LGI Homes’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of LGI Homes until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
LGI Homes doesn’t pass our quality test. After the recent drawdown, the stock trades at 7.5× forward P/E (or $57.05 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are superior stocks to buy right now. Let us point you toward our favorite semiconductor picks and shovels play.
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