Meritage Homes trades at $71.01 per share and has stayed right on track with the overall market, gaining 9.5% over the last six months. At the same time, the S&P 500 has returned 4.5%.
Is there a buying opportunity in Meritage Homes, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why do we think Meritage Homes will underperform?
We’re sitting this one out for now. Here are three reasons you should be careful with MTH, plus one stock we’d rather own.
1. Backlog declines as orders drop
We can better understand home builders companies by analyzing their backlog. This metric shows the value of outstanding orders that have not yet been executed or delivered, giving visibility into Meritage Homes’s future revenue streams.
Meritage Homes’s backlog came in at $637.2 million in the latest quarter, and it averaged 24.4% year-on-year declines over the last two years. This performance was underwhelming and shows the company is not winning new orders. It also suggests there may be increasing competition or market saturation. 
2. New investments fail to bear fruit as ROIC declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
Unfortunately, Meritage Homes’s ROIC has decreased significantly over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
3. High debt levels increase risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
Meritage Homes’s $3.66 billion of debt exceeds the $677.5 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $403.9 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Meritage Homes could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Meritage Homes can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final judgment
We cheer for all companies making their customers lives easier, but in the case of Meritage Homes, we’ll be cheering from the sidelines. That said, the stock currently trades at 17× forward P/E (or $71.01 per share). This multiple tells us a lot of good news is priced in - we think other companies feature superior fundamentals at the moment. Let us point you toward a top digital advertising platform riding the creator economy.
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