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Leon's Furniture (TSE:LNF) has had a rough three months with its share price down 23%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Leon's Furniture's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Leon's Furniture is:
24% = CA$191m ÷ CA$809m (Based on the trailing twelve months to March 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.24 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of Leon's Furniture's Earnings Growth And 24% ROE
Firstly, we acknowledge that Leon's Furniture has a significantly high ROE. Even when compared to the industry average of 21% the company's ROE is pretty decent. So, Leon's Furniture's moderate 17% growth over the past five years was probably backed by the high ROE.
As a next step, we compared Leon's Furniture'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 12%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Leon's Furniture is trading on a high P/E or a low P/E, relative to its industry.
Is Leon's Furniture Making Efficient Use Of Its Profits?
Leon's Furniture has a three-year median payout ratio of 30%, which implies that it retains the remaining 70% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Moreover, Leon's Furniture is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.
On the whole, we feel that Leon's Furniture's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard will have the 1 risk we have identified for Leon's Furniture.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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