Is Lycopodium Limited's (ASX:LYL) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Lycopodium's (ASX:LYL) stock is up by a considerable 21% 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 Lycopodium's ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Lycopodium

How Is ROE Calculated?

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 Lycopodium is:

15% = AU$12m ÷ AU$78m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.15 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Lycopodium's Earnings Growth And 15% ROE

To begin with, Lycopodium seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 10%. This certainly adds some context to Lycopodium's exceptional 36% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Lycopodium's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 28% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Lycopodium fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Lycopodium Efficiently Re-investing Its Profits?

Lycopodium's significant three-year median payout ratio of 68% (where it is retaining only 32% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Additionally, Lycopodium 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 75%. However, Lycopodium's ROE is predicted to rise to 19% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we are quite pleased with Lycopodium's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. 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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