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Will Weakness in Ralph Lauren Corporation's (NYSE:RL) Stock Prove Temporary Given Strong Fundamentals?

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Ralph Lauren (NYSE:RL) has had a rough month with its share price down 8.4%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Ralph Lauren's ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Ralph Lauren

How To Calculate Return On Equity?

ROE 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 Ralph Lauren is:

14% = US$404m ÷ US$2.9b (Based on the trailing twelve months to September 2021).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $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. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Ralph Lauren's Earnings Growth And 14% ROE

At first glance, Ralph Lauren seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 16%. This certainly adds some context to Ralph Lauren's moderate 6.2% net income growth seen over the past five years.

When you consider the fact that the industry earnings have shrunk at a rate of 12% in the same period, the company's net income growth is pretty remarkable.

past-earnings-growth
past-earnings-growth

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 RL fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Ralph Lauren Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 45% (implying that the company retains 55% of its profits), it seems that Ralph Lauren is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Ralph Lauren 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. 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 40%. Still, forecasts suggest that Ralph Lauren's future ROE will rise to 23% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we are quite pleased with Ralph Lauren's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.