Over the last six months, Meritage Homes’s shares have sunk to $70.63, producing a disappointing 6% loss - a stark contrast to the S&P 500’s 5% gain. This may have investors wondering how to approach the situation.

Is there a buying opportunity in Meritage Homes, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.

Why Do We Think Meritage Homes Will Underperform?

Even with the cheaper entry price, we're cautious about Meritage Homes. Here are three reasons why 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 $812.4 million in the latest quarter, and it averaged 38.2% 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. Free Cash Flow Margin Dropping

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

As you can see below, Meritage Homes’s margin dropped by 15.7 percentage points over the last five years. Almost any movement in the wrong direction is undesirable because of its already low cash conversion. If the trend continues, it could signal it’s becoming a more capital-intensive business. Meritage Homes’s free cash flow margin for the trailing 12 months was negative 6%.

3. New Investments Fail to Bear Fruit as ROIC Declines

ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative 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. 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. Following the recent decline, the stock trades at 7.9× forward P/E (or $70.63 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better stocks to buy right now. We’d recommend looking at one of our top software and edge computing picks.

Stocks We Would Buy Instead of Meritage Homes

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