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$LEN: Consistent earnings, treasury stock buybacks, and 18% year-over-year earnings growth!
Summary: I typically project the stock price of a companies shares by taking the long term United States federal borrowing rate and dividing the earnings by the said borrowing rate. When I tpyically do this calculation, the stock price is usually close to the current stock price. When I projected $LEN, Lennar, their stock price was projected to be nearly DOUBLE than the current stock price. Below I will be breaking down the the balance sheet, income statement (profit and loss statement), and the statement of cash flows.
Income Statement Analysis:
Gross profit is how much money the company made off of the total revenue after subtracting costs of the raw goods and the labor used to make the goods. By itself, it does not tell us much about the economics of the comapny. But by dividing the gross profits by total revenues, we can learn a lot more.
Here the high 20% gross profit margin is good, but not amazing. We would typically see companies with 40% of greater gross profit margins to have strong competive advantages in their respective industries.
We do not want to see high R&D or increasing / inconsistent SG&A expense. Lennar does not have any R&D expense, very good. Their SG&A expense is also consistently increasing. However, it is in very minimal amounts and is expected if earning grow year over year.
The higher the net earnings / revenue percentage the better. Typically, the company with the highest net earnings / revenue has the competitive advantage in their industry. A company consistently reporting 10% or less is usually in a very competitive industry. We see Lennar just above that threshold, which is not for concern if we like the other financial metrics.
Their earnings per share growth is impressive. Although, we need at least 10 years of data to ascertain any trend in EPS.
Balance Sheet Analysis
The current ratio is current assets divided by current liabilities. It is basically a liquidity test if the company can cover their current liabilities with current assets like cash. It doesn’t really tell us a ton about a company. We would be concerned if the company did have significant current liabilities compared to current assets. Lennar looks like it should have zero problem paying their current liabilities as their ratio is over 4. Typically, any ratio above 1 is considered good.
I found the PPE/Debt ratio interesting. We usually want the company to have more PPE than debt, but that is not the case here. After reviewing the balance sheet, Lennar keeps most of its’ assets in their inventories accounts. I don’t find this ratio concerning because their interest expense is only 0.28% of their reported operating profit. This is an extremely low amount and the company clearly has the capital to pay off their debts.
While many analysts believe the return on assets (net income / total assets) is the holy grail, it is not as predictive as some would suggest. We are looking for companies with competitive advantages. Why? Because companies with competitive advantages have the most long-term success. A more important figure here is the total assets. If Lennar has 37 billion in total assets, are competitors likely going to raise enough capital to compete with them? Possibly, but it is much harder the larger the total assets.
The debt to equity represents the capital structure of the company. Is the company taking on debt to raise money? Think bank loans or the sale of bonds. Or, is the company issuing shares to raise money? Too much long term debt can cripple a company, so this is something we look to avoid. Here, Lennar has a healthy debt to equity ratio below 1. Meaning they are raising more capital through the issuance of equity (shares) than taking on more long-term debt, which is very good!
The adjusted debt to equity is there to include treasury stock. Why? Treasury stock is stock that is issued by the company, and then later bought back from the public. Sound ridiculous? It is. But it’s awesome.
When companies have significant earnings power, they can do two things to increase their stock holders value. They can distribute dividends, or they can repurchase shares. Repurchasing shares increases the value of the companies stock as there is less supply for the stock. Typically, struggling companies will never repurchase their own shares because they are strapped for cash. Here, Lennar shows a history of treasury stock repurchasing. We will see it more in the cash flow statement.
When evaluating retained earnings in fundamental analysis, we want to see a consistent uptrend. Here, Lennar is reporting a consistent up trend. Exactly what we look for. Retained earnings is the earnings of all periods combined. Think of retained earnings as a big war chest the company is using / has.
Return on equity (ROE) is one of the most important financial metrics.
High returns on equity mean that the company is making good use of the earnings it is retaining. As time goes by, these high returns on equity will add up and increase the underlying value of the company, which, over time, will eventually be realized by the stock market through increasing of the company’s stock price.
Statement of Cash Flows
Unlike other analysts, we do not care as much about cash flow. Cash can be used to repurchase shares, which would decrease a periods cash flow. Therefore, if we see repurchasing of shares, we can likely infer the company is in a very good economic condition. In the snippet above, we see repurchasing occuring in Lennar’s statement of cash flows.
The only other metric we care about is CapEx as a ratio of Net Income. If a company has very high CapEx, it is unlikely to be in a very strong financial position. Lennar has a very low amount of resources going to CapEx, which is a great sign.
Valuation: Earnings History and EPS (Earnings Per Share)
This is where the fireworks happen, so get excited. When analyzing earnings and EPS (earnings per share) we want to see two things. Consistency in earnings is the first thing. We want to see consistent earnings over a period of time for both earnings and EPS. The second thing we look for is an uptrend in both earnings and EPS. When companies have consistent earnings and EPS, good / above average return on equity, a habbit of repurchasing stock, favorable capital structure (debt < equity), and controlled expenses, the company is likely a great investment.
Time for the fireworks, let’s take a look at Lennar’s earnings and EPS so see if it is both consistent and in an uptrend.
Tell me. Does earnings and EPS reflect a consistent uptrend? I would certainly say so. This is very promising and makes me excited! This should make you exicted too!
At the bottom is a valuation tool I use on every stock. I take the current federal long term borrowing rate and divide the current EPS by it.
Why? Think of $LEN, Lennar, stock as a bond instead of a stock. If you wanted to buy a bond that yields a 4% return and gives you $13.73 in annual income, you would have to pay $343.25 for said bond.
What does this mean? In essence, you should have to pay $343.25 to buy a bond that yields 4% returning $13.73 annually. But what is the current $LEN stock price? The current price is around $150! Are you starting to realize how powerful this is? The stock is almost half of the intrinsic value that it should be priced at. The stock market will eveltually realize this and $LEN stock will rise.
If you bought today, you would be buying a stock yielding 9% annually that grows by an average of 18% per year. I mean talk about compounding! This is not even accounting for the appreciation in the stock’s price!
To summarize, I love $LEN for a long-term buy and hold.
Check out some other financial breakdowns here:
