Is Lojas Renner S.A.'s (BVMF:LREN3) Recent Performance Underpinned By Weak Financials?

With its stock down 14% over the past three months, it is easy to disregard Lojas Renner (BVMF:LREN3). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on Lojas Renner'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Lojas Renner

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Lojas Renner is:

13% = R$1.3b ÷ R$10b (Based on the trailing twelve months to December 2022).

The 'return' refers to a company's earnings over the last year. So, this means that for every R$1 of its shareholder's investments, the company generates a profit of R$0.13.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 Lojas Renner's Earnings Growth And 13% ROE

When you first look at it, Lojas Renner's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 12%, so we won't completely dismiss the company. On the other hand, Lojas Renner reported a fairly low 2.6% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

As a next step, we compared Lojas Renner's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 11% 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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Lojas Renner is trading on a high P/E or a low P/E, relative to its industry.

Is Lojas Renner Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 50% (or a retention ratio of 50%), most of Lojas Renner's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, Lojas Renner has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 31% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 18%, over the same period.

Conclusion

On the whole, Lojas Renner's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.