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Lendlease Group (ASX:LLC) has had a rough month with its share price down 12%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Lendlease Group's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
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 Lendlease Group is:
6.5% = AU$420m ÷ AU$6.5b (Based on the trailing twelve months to December 2019).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.06 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
A Side By Side comparison of Lendlease Group's Earnings Growth And 6.5% ROE
On the face of it, Lendlease Group's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.2%. But then again, Lendlease Group's five year net income shrunk at a rate of 4.7%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 1.4% in the same period, we found that Lendlease Group's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Lendlease Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Lendlease Group Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 49% (where it is retaining 51% of its profits), Lendlease Group has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, Lendlease Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 48%. Regardless, the future ROE for Lendlease Group is predicted to rise to 9.1% despite there being not much change expected in its payout ratio.
In total, we're a bit ambivalent about Lendlease Group's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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