Most readers would already be aware that Linamar’s (TSE:LNR) stock increased significantly by 13% over the past three months. However, we wonder if the company’s inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Linamar’s ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Linamar
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 Linamar is:
8.9% = CA$447m ÷ CA$5.0b (Based on the trailing twelve months to March 2023).
The ‘return’ is the income the business earned over the last year. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.09 in profit.
Why Is ROE Important For Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. 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.
A Side By Side comparison of Linamar’s Earnings Growth And 8.9% ROE
When you first look at it, Linamar’s ROE doesn’t look that attractive. Yet, a closer study shows that the company’s ROE is similar to the industry average of 7.8%. But Linamar saw a five year net income decline of 9.0% over the past five years. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.
With the industry earnings declining at a rate of 10% in the same period, we deduce that both the company and the industry are shrinking at the same rate.
Earnings growth is an important metric to consider when valuing a stock. 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. Is Linamar fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Linamar Making Efficient Use Of Its Profits?
Linamar’s low three-year median payout ratio of 11% (or a retention ratio of 89%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company’s earnings have actually shrunk. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.
Additionally, Linamar has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth.
Summary
Overall, we have mixed feelings about Linamar. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 1 risk we have identified for Linamar 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.
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