I’m going to post this as-is because it is already a week past its shelf life. Saul posted recently about LGIH revenue and earnings growth and p/e. This will talk a little bit about the p/e. It gets to a point of discussing NASDAQ website Guru Analysis and then it ends. I’m not going to finish that part right now and still have an analysis of the options thAT LGI Homes has to “improve” its cash flow and debt “problems”.
So, a three subject post: 1) investing in cyclical industries, 2) comparison of p/e’s among LGIH and its industry peers, 3) a search for reasons for the low p/e of LGIH and grading the market’s concerns (very partial).
Cyclicals. I don’t have the slightest experience in investing in cyclical industries as a strategy. However, a quick google of key words such as ‘p/e’, ‘cyclical’, and ‘investing’ directs to numerous articles which say “buy high, sell low”, as far as p/e’s are concerned. The common knowledge of the market is that there is a degree of boom and bust so the stocks are not richly rewarded in good times nor severely punished in the downside of the economic cycle. As a result, the high “e” during the up cycle gives a relatively low “p”, thus a low p/e when the economic cycle is toward the top. At the bottom of the cycle the price is supported by the “knowledge” that good times must be ahead and so the low “e” earns a relatively high “p” and therefore a high p/e. This is even more so if the company pays a dividend. Assuming the market forecast on the economic cycle is correct, you buy the high p/e at the beginning of the economic up cycle and sell the low p/e at the beginning of economic down cycle. A lot of the home builders have had strong earning increases of 25% over the past couple of years, and the recovery is what, 6 or 7 years old? So, we need to look further for indications of where we are in the p/e cycle. I suppose we would have to go back to 2007 to look at the beginning of down cycle. But that was not your garden variety economic cycle. So even that might not be instructive and I didn’t come across the data. The p/e’s of the three largest home builders have been decreasing. DHI has ended the last four years with p/e’s of (very roughly based on eyeballing year end chart data) 18, 16, 13, and now about 12. LEN ended at 15, 16, 14 and 12. PHM had an odd p/e of 4 but then 17,13 and 12. This shows the falling p/e in an up cycle but again, we don’t know how low is typically low.
LGIH Versus Peers. I have 22 home builders listed. I threw out three: one had no earnings, one had a p/e of 102 and one had 2.68. Of the remaining 19, the average p/e is 13.66. The median is 12.55. The three largest companies have p/e’s of 11.93, 12.55 and 11.84. The high p/e is 24.88, and the low p/e is 8.77. LGIH has the second lowest p/e, 9.26. Unfortunately this is a single data point based on the closing prices on December 16. The market knows LGIH has a relatively low p/e and doesn’t care. It is not rewarding LGIH’s superior growth in revenue and earnings. LGIH is a growth company in a cyclical industry and is being priced as an inferior cyclical company. Century Communities is in the same boat. Definitely a clash in valuation criteria and the cyclical investors are in charge right now.
As far as the cycle is concerned, I suppose that three issues are the economic cycle itself, interest rates and housing supply. My own guess is that the economic expansion still has legs, increased interest rates will be small and not significantly reduce the number of qualified buyers, and the housing shortage will be persistent for years (then add economist-speak such as “barring unexpected economic shock”).
This would mean that LGIH would build more and more homes and make more money and the share price would increase, but not as fast as earnings, so even lower p/e may be ahead. Nothing very revealing here.
Why Does LGIH Have a Low P/E?
I suspect three reasons: 1) negative free cash flow, 2) high debt to equity, 3) earnings comps.
In digging into the homebuilders, I happened upon the NASDAQ web site while hunting financial ratios and p/e’s. They have something they call Guru Analysis. What they do is use the investing guidelines or screens of presumably famous or influential investment professionals or groups and analyze a company on those basis. These are Lynch, Graham, Validea, Motley Fool Small Cap Growth, Zweig, O’Shaunessey, Fisher and Dreman. Some of these are value, some are momentum, some are small cap growth, etc., etc. In many cases, trying to apply the criteria to the whole spectrum of stocks is just silly, but let’s look at a couple.
What does Zweig Guru say’.
TOTAL DEBT/EQUITY RATIO: [FAIL]
A final criterion is that a company must not have a high level of debt. A high level of total debt, due to high interest expenses, can have a very negative effect on earnings if business moderately turns down. If a company does have a high level, an investor may want to avoid this stock altogether. LGIH’s Debt/Equity (107.38%) is considered high relative to its industry (59.56%) and fails this test.
Sorry, That’s All Folks,
KC
). The last few years we have benefited from low gas price and that could turn out to be a headwind.