At Home With Homebuilders

01/29/2018 5:00 am EST


John Reese

Founder and CEO, And Validea Capital Management

John Reese assesses stocks based on the fundamental and technical criteria of the market's most legendary investors. In his newsletter, Validea, he recommends two homebuilding stocks, on based on the Motley Fool small cap growth strategy and one based on Peter Lynch's price to earnings growth strategy.

LGI Homes, Inc. (LGIH) is a homebuilder and land developer. The company is engaged in the design, construction, marketing and sale of new homes in markets in Texas, Arizona, Florida, Georgia, New Mexico, South Carolina, North Carolina, Colorado, Washington and Tennessee.

This methodology seeks companies with a minimum trailing 12 month after tax profit margin of 7%. The companies that pass this criterion have strong positions within their respective industries and offer greater shareholder returns. A true test of the quality of a company is that they can sustain this margin. LGIH's profit margin of 9.26% passes this test.

Companies whose relative strength is 90 or above (that is, the company outperforms 90% or more of the market for the past year), are considered attractive. Companies whose price has been rising much quicker than the market tend to keep rising. LGIH, with a relative strength of 95, satisfies this test.


Companies must demonstrate both revenue and net income growth of at least 25% as compared to the prior year. These growth rates give you the dynamic companies that you are looking for. These rates for LGIH (62.79% for EPS, and 69.16% for Sales) are good enough to pass.

LGIH's profit margin has been consistent or even increasing over the past three years (Current year: 8.95%, last year: 8.38%, two years ago: 7.36%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise.

The "Fool Ratio" is an extremely important aspect of this analysis. If the company has attractive fundamentals and its Fool Ratio is 0.5 or less (LGIH's is 0.28), the shares are looked upon favorably. These high quality companies can often wind up as the biggest winners. LGIH passes this test.

Toll Brothers, Inc. (TOL) is engaged in designing, building, marketing, selling and arranging financing for detached and attached homes in luxury residential communities.

TOL is considered a "True Stalwart", according to this methodology, as its earnings growth of 18.73% lies within a moderate 10%-19% range and its annual sales of $5,815 million are greater than the multi billion dollar level.

This methodology looks for the "Stalwart" securities to gain 30%-50% in value over a two year period if they can be purchased at an attractive price based on the P/E to Growth ratio. TOL is attractive if TOL can hold its own during a recession.

When inventories increase faster than sales, it is a red flag. However an increase of up to 5% is considered bearable if all other ratios appear attractive. Inventory to sales for TOL was 142.26% last year, while for this year it is 125.22%. Since inventory to sales has decreased from last year by -17.04%, TOL passes this test.

The Yield-adjusted P/E/G ratio for TOL (0.84), based on the average of the 3, 4 and 5 year historical eps growth rates, is O.K. The EPS for a stalwart company must be positive. TOL's EPS ($3.18) would satisfy this criterion.

This methodology would consider the Debt/Equity ratio for TOL (71.06%) to be mediocre. If the Debt/Equity ratio is this high, the other ratios and financial statistics for TOL should be good enough to compensate.

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