In This Article:
Most readers would already be aware that LGI's (ASX:LGI) stock increased significantly by 37% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study LGI's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for LGI
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 LGI is:
14% = AU$7.1m ÷ AU$52m (Based on the trailing twelve months to December 2023).
The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.14 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
A Side By Side comparison of LGI's Earnings Growth And 14% ROE
At first glance, LGI seems to have a decent ROE. On comparing with the average industry ROE of 2.5% the company's ROE looks pretty remarkable. This certainly adds some context to LGI's exceptional 35% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing LGI's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 35% over the last few years.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is LGI fairly valued compared to other companies? These 3 valuation measures might help you decide.