LGI Homes has been treading water for the past six months, recording a small loss of 4.7% while holding steady at $48.22. The stock also fell short of the S&P 500’s 11% gain during that period.
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Why Do We Think LGI Homes Will Underperform?
We’re sitting this one out for now. Here are three reasons why LGIH doesn’t excite us, plus one stock we’d rather own.
1. Revenue Spiraling Downwards
A company’s long-term sales performance is one signal of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. LGI Homes’s demand was weak over the last five years as its sales fell at a 8.6% annual rate. This was below our standards and is a sign of poor business quality.
2. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared 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. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
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 $69.16 million of cash over the last year, and its $1.71 billion of debt exceeds the $60.86 million of 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
We cheer for all companies making their customers lives easier, but in the case of LGI Homes, we’ll be cheering from the sidelines. With its shares underperforming the market lately, the stock trades at 14.6× forward P/E (or $48.22 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think other companies feature superior fundamentals at the moment. Let us point you toward our favorite semiconductor picks and shovels play.
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