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Most readers would already be aware that El Pollo Loco Holdings' (NASDAQ:LOCO) stock increased significantly by 16% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study El Pollo Loco Holdings' ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for El Pollo Loco Holdings is:
8.3% = US$23m ÷ US$271m (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
El Pollo Loco Holdings' Earnings Growth And 8.3% ROE
When you first look at it, El Pollo Loco Holdings' ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 8.3%, we may spare it some thought. But then again, El Pollo Loco Holdings' five year net income shrunk at a rate of 15%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.
That being said, we compared El Pollo Loco Holdings' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.2% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about El Pollo Loco Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is El Pollo Loco Holdings Making Efficient Use Of Its Profits?
In total, we're a bit ambivalent about El Pollo Loco Holdings' performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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