LGI Homes (NASDAQ:LGIH) Is Reinvesting At Lower Rates Of Return
To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think LGI Homes (NASDAQ:LGIH) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on LGI Homes is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = US$234m ÷ (US$3.1b - US$112m) (Based on the trailing twelve months to June 2023).
Therefore, LGI Homes has an ROCE of 7.7%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 15%.
Check out our latest analysis for LGI Homes
Above you can see how the current ROCE for LGI Homes compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering LGI Homes here for free.
So How Is LGI Homes' ROCE Trending?
When we looked at the ROCE trend at LGI Homes, we didn't gain much confidence. To be more specific, ROCE has fallen from 18% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
In Conclusion...
In summary, we're somewhat concerned by LGI Homes' diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 101%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you'd like to know more about LGI Homes, we've spotted 2 warning signs, and 1 of them is concerning.
While LGI Homes isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
