It is hard to get excited after looking at LS 2 Holdings' (Catalist:ENV) recent performance, when its stock has declined 15% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on LS 2 Holdings' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 LS 2 Holdings

How Do You 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 LS 2 Holdings is:

3.9% = S$636k ÷ S$16m (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.04 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

LS 2 Holdings' Earnings Growth And 3.9% ROE

It is hard to argue that LS 2 Holdings' ROE is much good in and of itself. Not just that, even compared to the industry average of 8.5%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 16% seen by LS 2 Holdings over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared LS 2 Holdings' 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 14% in the same period.