Lennar Corporation (NYSE:LEN) and Toll Brothers, Inc. (NYSE:TOL) are the two most active stocks in the Residential Construction industry based on today’s trading volumes. The market is clearly enthusiastic about both these stocks, but which is the better investment? To answer this, we will compare the two companies based on the strength of their growth, profitability, risk, returns, valuation, analyst recommendations, and insider trends.
Companies that can increase earnings at a high compound rate over time are attractive to investors. Analysts expect LEN to grow earnings at a 9.26% annual rate over the next 5 years. Comparatively, TOL is expected to grow at a 13.56% annual rate. All else equal, TOL’s higher growth rate would imply a greater potential for capital appreciation.
Profitability and Returns
Growth in and of itself is not necessarily valuable, and it can even be harmful to shareholders if companies overinvest in unprofitable projects in pursuit of that growth. We will use EBITDA margin and Return on Investment (ROI), which adjust for differences in capital structure, as measure of profitability and return. Lennar Corporation (LEN) has an EBITDA margin of 5.84%, compared to an EBITDA margin of 12.5% for Toll Brothers, Inc. (TOL). This suggests that TOL underlying business is more profitable. LEN’s ROI is 6.90% while TOL has a ROI of 3.50%. The interpretation is that LEN’s business generates a higher return on investment than TOL’s.
The value of a stock is simply the present value of its future free cash flows. LEN’s free cash flow (“FCF”) per share for the trailing twelve months was -0.93. Comparatively, TOL’s free cash flow per share was +0.82. On a percent-of-sales basis, LEN’s free cash flow was -1.99% while TOL converted 2.59% of its revenues into cash flow. This means that, for a given level of sales, TOL is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Balance sheet risk is one of the biggest factors to consider before investing. LEN’s debt-to-equity ratio is 1.00 versus a D/E of 0.84 for TOL. LEN is therefore the more solvent of the two companies, and has lower financial risk.
LEN trades at a forward P/E of 11.59, a P/B of 1.78, and a P/S of 1.08, compared to a forward P/E of 11.87, a P/B of 1.53, and a P/S of 1.17 for TOL. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.
Risk and Volatility
Beta is a metric that investors frequently use to analyze a stock’s systematic risk. A beta above 1 implies above average market volatility. Conversely, a stock with a beta below 1 is seen as less risky than the overall market. LEN has a beta of 1.22 and TOL’s beta is 1.49. LEN’s shares are therefore the less volatile of the two stocks.
Insider Activity and Investor Sentiment
Comparing the number of shares sold short to the float is a method analysts often use to get a reading on investor sentiment. LEN has a short ratio of 3.88 compared to a short interest of 4.02 for TOL. This implies that the market is currently less bearish on the outlook for LEN.
Toll Brothers, Inc. (NYSE:TOL) beats Lennar Corporation (NYSE:LEN) on a total of 6 of the 11 factors compared between the two stocks. TOL generates a higher return on investment, is more profitable, has higher cash flow per share, has a higher cash conversion rate and has lower financial risk. Finally, KBH has better sentiment signals based on short interest.