It is hard to get excited after looking at LondonMetric Property's (LON:LMP) recent performance, when its stock has declined 2.4% over the past month. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to LondonMetric Property's ROE today.
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 Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for LondonMetric Property is:
5.6% = UK£89m ÷ UK£1.6b (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £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. 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 LondonMetric Property's Earnings Growth And 5.6% ROE
At first glance, LondonMetric Property's ROE doesn't look very promising. However, its ROE is similar to the industry average of 5.7%, so we won't completely dismiss the company. But then again, LondonMetric Property's five year net income shrunk at a rate of 8.0%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.
That being said, we compared LondonMetric Property's 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 9.6% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for LMP? You can find out in our latest intrinsic value infographic research report.
Is LondonMetric Property Using Its Retained Earnings Effectively?
LondonMetric Property has a very high three-year median payout ratio of 100%, implying that it retains only 0.3% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. Accordingly, this likely explains why its earnings have been shrinking.
Moreover, LondonMetric Property 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 103%. As a result, LondonMetric Property's ROE is not expected to change by much either, which we inferred from the analyst estimate of 5.4% for future ROE.
On the whole, LondonMetric Property's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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. 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.
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