Meritage Homes has been treading water for the past six months, recording a small loss of 1.9% while holding steady at $67.38. The stock also fell short of the S&P 500’s 10.8% gain during that period.

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Why Do We Think Meritage Homes Will Underperform?

We're sitting this one out for now. Here are three reasons there are better opportunities than MTH and a stock we'd rather own.

1. Backlog Declines as Orders Drop

In addition to reported revenue, backlog is a useful data point for analyzing Home Builders companies. 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 $670 million in the latest quarter, and it averaged 34.4% 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. EPS Took a Dip Over the Last Two Years

While long-term earnings trends give us the big picture, we also track EPS over a shorter period because it can provide insight into an emerging theme or development for the business.

Sadly for Meritage Homes, its EPS declined by more than its revenue over the last two years, dropping 16.8%. This tells us the company struggled to adjust to shrinking demand.

3. New Investments Fail to Bear Fruit as ROIC Declines

A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Meritage Homes’s ROIC has unfortunately decreased significantly. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

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. With its shares trailing the market in recent months, the stock trades at 9.8× forward P/E (or $67.38 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better investments elsewhere. We’d recommend looking at an all-weather company that owns household favorite Taco Bell.

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