Leon's Furniture's (TSE:LNF) stock is up by a considerable 5.9% over the past week. 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 Leon's Furniture's ROE in this article.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Leon's Furniture is:
21% = CA$204m ÷ CA$981m (Based on the trailing twelve months to September 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.21 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. 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 Leon's Furniture's Earnings Growth And 21% ROE
To begin with, Leon's Furniture seems to have a respectable ROE. Even when compared to the industry average of 22% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 17% seen over the past five years by Leon's Furniture.
Next, on comparing with the industry net income growth, we found that Leon's Furniture's growth is quite high when compared to the industry average growth of 8.4% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Leon's Furniture's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Leon's Furniture Efficiently Re-investing Its Profits?
With a three-year median payout ratio of 36% (implying that the company retains 64% of its profits), it seems that Leon's Furniture is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Additionally, Leon's Furniture 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.
In total, we are pretty happy with Leon's Furniture's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 1 risk we have identified for Leon's Furniture visit our risks dashboard for free.
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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.