Yahoo Finance With An ROE Of 24.5%, Has Lumentum Holdings Inc’s (NASDAQ:LITE) Management Done Well?
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between company’s fundamentals and stock market performance.
Lumentum Holdings Inc (NASDAQ:LITE) delivered an ROE of 24.5% over the past 12 months, which is an impressive feat relative to its industry average of 9.5% during the same period. While the impressive ratio tells us that LITE has made significant profits from little equity capital, ROE doesn’t tell us if LITE has borrowed debt to make this happen. Today, we’ll take a closer look at some factors like financial leverage to see how sustainable LITE’s ROE is.
See our latest analysis for Lumentum Holdings
What you must know about ROE
Return on Equity (ROE) weighs Lumentum Holdings’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.24 in earnings from this. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Lumentum Holdings’s cost of equity is 10.3%. Since Lumentum Holdings’s return covers its cost in excess of 14.1%, its use of equity capital is efficient and likely to be sustainable. Simply put, Lumentum Holdings pays less for its capital than what it generates in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Lumentum Holdings can generate with its current asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be artificially increased through excessive borrowing, we should check Lumentum Holdings’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 33.7%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Lumentum Holdings exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. Although ROE can be a useful metric, it is only a small part of diligent research.
For Lumentum Holdings, I’ve put together three pertinent factors you should further research:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Valuation: What is Lumentum Holdings worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Lumentum Holdings is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Lumentum Holdings? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
