Lookers' (LON:LOOK) stock is up by a considerable 18% over the past three months. 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. Specifically, we decided to study Lookers' ROE in this article.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Lookers
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Lookers is:
19% = UK£77m ÷ UK£410m (Based on the trailing twelve months to June 2022).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.19 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
A Side By Side comparison of Lookers' Earnings Growth And 19% ROE
At first glance, Lookers seems to have a decent ROE. Even when compared to the industry average of 17% the company's ROE looks quite decent. Given the circumstances, we can't help but wonder why Lookers saw little to no growth in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that Lookers' reported growth was lower than the industry growth of 8.6% 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. 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 Lookers is trading on a high P/E or a low P/E, relative to its industry.