- Oops!Something went wrong.Please try again later.
Most readers would already be aware that Linde's (NYSE:LIN) stock increased significantly by 12% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Linde's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
Return on equity 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 Linde is:
5.3% = US$2.6b ÷ US$50b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.05.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Linde's Earnings Growth And 5.3% ROE
When you first look at it, Linde's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. However, the moderate 17% net income growth seen by Linde over the past five years is definitely a positive. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Linde's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.5%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Linde fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Linde Efficiently Re-investing Its Profits?
Linde has a significant three-year median payout ratio of 69%, meaning that it is left with only 31% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Additionally, Linde has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 45% over the next three years. The fact that the company's ROE is expected to rise to 11% over the same period is explained by the drop in the payout ratio.
On the whole, we do feel that Linde has some positive attributes. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.