Lear’s (NYSE:LEA) stock was mostly flat over the past three months. However, its worth giving the company a closer given that its key financial performance indicators aren’t particularly bad and long-term financial health is usually what drive market prices. In this article, we decided to focus on Lear’s 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Lear
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 Lear is:
12% = US$607m ÷ US$5.1b (Based on the trailing twelve months to July 2023).
The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.12 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.
Lear’s Earnings Growth And 12% ROE
To start with, Lear’s ROE looks acceptable. Further, the company’s ROE is similar to the industry average of 12%. For this reason, Lear’s five year net income decline of 33% raises the question as to why the decent ROE didn’t translate into growth. So, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
However, when we compared Lear’s growth with the industry we found that while the company’s earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. Is Lear fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Lear Efficiently Re-investing Its Profits?
Despite having a normal three-year median payout ratio of 43% (where it is retaining 57% of its profits), Lear has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Lear 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. Existing analyst estimates suggest that the company’s future payout ratio is expected to drop to 15% over the next three years. As a result, the expected drop in Lear’s payout ratio explains the anticipated rise in the company’s future ROE to 20%, over the same period.
Conclusion
In total, it does look like Lear has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.