Is Loblaw Companies Limited's (TSE:L) Recent Price Movement Underpinned By Its Weak Fundamentals?

Loblaw Companies (TSE:L) has had a rough three months with its share price down 3.3%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Loblaw Companies' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Loblaw Companies

How Is ROE Calculated?

Return on equity 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 Loblaw Companies is:

9.5% = CA$1.1b ÷ CA$11b (Based on the trailing twelve months to October 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.10 in profit.

What Has ROE Got To Do With 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. 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.

Loblaw Companies' Earnings Growth And 9.5% ROE

On the face of it, Loblaw Companies' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. As a result, Loblaw Companies reported a very low income growth of 4.0% over the past five years.

We then compared Loblaw Companies' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.6% in the same period, which is a bit concerning.

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 Loblaw Companies fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Loblaw Companies Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 43% (or a retention ratio of 57% over the past three years, Loblaw Companies has seen very little growth 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, Loblaw Companies 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 24% over the next three years. As a result, the expected drop in Loblaw Companies' payout ratio explains the anticipated rise in the company's future ROE to 18%, over the same period.

Conclusion

In total, we're a bit ambivalent about Loblaw Companies' performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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