Could The Market Be Wrong About LGI Homes, Inc. (NASDAQ:LGIH) Given Its Attractive Financial Prospects?

By
Simply Wall St
Published
May 18, 2022
NasdaqGS:LGIH
Source: Shutterstock

With its stock down 21% over the past three months, it is easy to disregard LGI Homes (NASDAQ:LGIH). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for LGI Homes

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for LGI Homes is:

29% = US$409m ÷ US$1.4b (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.29 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 29% ROE

Firstly, we acknowledge that LGI Homes has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 20% also doesn't go unnoticed by us. Under the circumstances, LGI Homes' considerable five year net income growth of 34% was to be expected.

We then performed a comparison between LGI Homes' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 31% in the same period.

past-earnings-growth
NasdaqGS:LGIH Past Earnings Growth May 18th 2022

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about LGI Homes''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is LGI Homes Using Its Retained Earnings Effectively?

LGI Homes doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

Overall, we are quite pleased with LGI Homes' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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