Loblaw Companies Limited's (TSE:L) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?
Most readers would already be aware that Loblaw Companies' (TSE:L) stock increased significantly by 11% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Loblaw Companies' ROE.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Loblaw Companies
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 Loblaw Companies is:
14% = CA$1.5b ÷ CA$11b (Based on the trailing twelve months to June 2021).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.14 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.
Loblaw Companies' Earnings Growth And 14% ROE
To start with, Loblaw Companies' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 14%. Despite the modest returns, Loblaw Companies' five year net income growth was quite low, averaging at only 2.7%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that Loblaw Companies' reported growth was lower than the industry growth of 19% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is L fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Loblaw Companies Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 44% (implying that the company retains the remaining 56% of its income), Loblaw Companies' earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, Loblaw Companies has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 25% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Summary
On the whole, we do feel that Loblaw Companies has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
