Is LGI Homes, Inc.'s (NASDAQ:LGIH) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?
LGI Homes' (NASDAQ:LGIH) stock is up by a considerable 23% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to LGI Homes' ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for LGI Homes
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for LGI Homes is:
23% = US$213m ÷ US$919m (Based on the trailing twelve months to June 2020).
The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.23 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
LGI Homes' Earnings Growth And 23% ROE
To begin with, LGI Homes has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 14% also doesn't go unnoticed by us. As a result, LGI Homes' exceptional 29% net income growth seen over the past five years, doesn't come as a surprise.
As a next step, we compared LGI Homes' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 18%.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if LGI Homes is trading on a high P/E or a low P/E, relative to its industry.
Is LGI Homes Efficiently Re-investing Its Profits?
Given that LGI Homes doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
Conclusion
On the whole, we feel that LGI Homes' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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