Fiduciary Management, an investment management firm, published its “Small Cap Equity Fund” third quarter 2021 investor letter – a copy of which can be downloaded here. The FMI Small Cap portfolios gained approximately 0.6% in the September quarter compared to declines of 4.36% for the Russell 2000 Index and 2.98% for the Russell 2000 Value Index. You can take a look at the fund’s top 5 holdings to have an idea about their best picks for 2021.
Fiduciary Management, in its Q3 2021 investor letter, mentioned LGI Homes, Inc. (NASDAQ: LGIH) and discussed its stance on the firm. LGI Homes, Inc. is a Texas, United States-based construction company with a $3.4 billion market capitalization. LGIH delivered a 32.85% return since the beginning of the year, while its 12-month returns are up by 11.00%. The stock closed at $140.62 per share on October 18, 2021.
Here is what Fiduciary Management has to say about LGI Homes, Inc. in its Q3 2021 investor letter:
“LGI Homes engages in the design, construction, marketing, and sale of new single-family homes in the U.S. It participates in 34 markets across 18 states, with 9,339 closings per year as of 2020. It is the tenth largest residential homebuilder in the U.S., and focuses on building affordable, entry-level spec homes that are move-in ready. The company primarily markets its homes to renters in order to convert them into homeowners. It operates through the following segments: Central (39% of closings, 36% of revenues), Southeast (26% of closings, 24% of revenues), Florida (13% of closings, 12% of revenues), West (11% of closings, 12% of revenues), and Northwest (11% of closings, 16% of revenues). The company was founded in 2003, completed its IPO in 2013, and is headquartered in The Woodlands, Texas.
Good Business
• The company has a unique selling culture with a simple and differentiated business model that is easy to understand and consistently applied across every LGI Homes community in the U.S.
• Its homes are built quicker and more efficiently than a typical spec home because LGI uses even-flow production, allows for no customization by the buyer, and builds in sets of 3-4 homes simultaneously.
• LGI uses a highly successful direct-to-consumer sales model and is not reliant on realtors to bring potential buyers to its communities, like most peers. This makes the company less sensitive to underlying demand for housing than the average homebuilder.
• LGI has been profitable every year since its inception in 2003, even throughout the Great Financial Crisis.
• It has the highest monthly absorptions (homes closed per community per month) among other homebuilders, at seven homes per community, and has the highest gross margin out of its peers.
• LGI Homes’ communities are primarily located in southern geographies with favorable migration patterns.
• LGI is one of the only homebuilders that has earned returns above its cost of capital over the past decade. It has averaged a return on invested capital of ~14% over the past five years.
• The company’s balance sheet is in good shape, with a net debt-to-total capital ratio of 31% and a net debt-to-EBITDA of 0.9 times.Valuation
• The stock is trading at 8.3 times its trailing enterprise value-to-EBIT, which is over a standard deviation below the company’s 5-year average of 11.0 times.
• It trades at a forward price-to-earnings multiple (P/E) of 8.9 times, half a standard deviation below its 5-year average of 9.6 times. Management
• LGI management and directors own nearly 12% of the company, aligning their interests with shareholders, and all named executive officers have long tenures. The management team members are regarded as some of the best operators in the industry.
• CEO Eric Lipar is one of the founders of the company and owns over 9% of the shares.
• CFO Charles Merdian has been with the company for 17 years, and in his current position for 11.
• President and COO Michael Snider has also been with LGI for 17 years, and in his current position for 12 years.Investment Thesis
LGI Homes operates quite differently than most peers. What really sets the company apart is its unique, systematic approach in marketing to renters, training its sales staff, and identifying optimal locations to build communities. In contrast to many homebuilders that depend on realtors to bring buyers to their communities, LGI uses a direct-to-consumer approach to actively search for renters and convert them into homeowners. This model has proven extremely effective, as the company has sustainably higher monthly absorption (closing) rates, double its peers. This sales model has also proven to be a more durable and consistent way to sell homes, and better able to withstand a tougher economic environment. Additionally, LGI Homes is well-positioned to benefit from strong economic and secular trends in the industry, such as low U.S. home inventory, low interest rates, migration patterns to the south, strong demand for more affordable single-family housing, urban flight, and increased working from home. LGI should continue to outpace peers while generating good returns as it follows its superior sales model and expands into new communities.”
Based on our calculations, LGI Homes, Inc. (NASDAQ: LGIH) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. LGIH was in 17 hedge fund portfolios at the end of the first half of 2021, compared to 16 funds in the previous quarter. LGI Homes, Inc. (NASDAQ: LGIH) delivered a -12.50% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
