LGI Homes’s stock price has taken a beating over the past six months, shedding 29.1% of its value and falling to $40.94 per share. This was partly due to its softer quarterly results and might have investors contemplating their next move.

Is there a buying opportunity in LGI Homes, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.

Why Do We Think LGI Homes Will Underperform?

Even though the stock has become cheaper, we're sitting this one out for now. Here are three reasons you should be careful with LGIH and a 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 have short-term success, but a top-tier one grows for years. LGI Homes’s demand was weak over the last five years as its sales fell at a 6.4% annual rate. This wasn’t a great result and signals it’s a low quality business.

2. New Investments Fail to Bear Fruit as ROIC Declines

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 $140.9 million of cash over the last year, and its $1.66 billion of debt exceeds the $61.25 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 see the value of companies helping their customers, but in the case of LGI Homes, we’re out. After the recent drawdown, the stock trades at 17.5× forward P/E (or $40.94 per share). This valuation tells us a lot of optimism is priced in - we think there are better opportunities elsewhere. We’d suggest looking at one of our top software and edge computing picks.

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