Although Forestar Group (currently trading at $26.52 per share) has gained 5.8% over the last six months, it has trailed the S&P 500’s 12.7% return during that period. This was partly due to its softer quarterly results and might have investors contemplating their next move.
Is there a buying opportunity in Forestar Group, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Do We Think Forestar Group Will Underperform?
We’re passing on Forestar Group for now. Here are three reasons you should be careful with FOR, plus one stock we’d rather own.
1. Demand Slips as Sales Volumes Slide
Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Consumer Discretionary - Real Estate Services company because there’s a ceiling to what customers will pay.
Forestar Group’s number of lots sold came in at 3,659 in the latest quarter, and they averaged 18.6% year-on-year declines over the last two years. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Forestar Group might have to lower prices or invest in product improvements to grow, factors that can hinder near-term profitability. 
2. Cash Burn Ignites Concerns
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.
While Forestar Group posted positive free cash flow this quarter, the broader story hasn’t been so clean. Over the last two years, Forestar Group’s demanding reinvestments to stay relevant have drained its resources, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 1.7%, meaning it lit $1.66 of cash on fire for every $100 in revenue.
3. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
On average, Forestar Group’s ROIC decreased by 2.3 percentage points annually each year over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
We cheer for all companies serving everyday consumers, but in the case of Forestar Group, we’ll be cheering from the sidelines. With its shares lagging the market recently, the stock trades at 9.5× forward P/E (or $26.52 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are more exciting stocks to buy at the moment. Let us point you toward a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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