Is Weakness In Lonza Group Ltd (VTX:LONN) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 2.6% over the past three months, it is easy to disregard Lonza Group (VTX:LONN). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Lonza Group's ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Lonza Group

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 Lonza Group is:

13% = CHF848m ÷ CHF6.5b (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CHF1 worth of equity, the company was able to earn CHF0.13 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Lonza Group's Earnings Growth And 13% ROE

To begin with, Lonza Group seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. This certainly adds some context to Lonza Group's exceptional 25% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Lonza Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 16%.

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). This then helps them determine if the stock is placed for a bright or bleak future. Is Lonza Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Lonza Group Using Its Retained Earnings Effectively?

The three-year median payout ratio for Lonza Group is 28%, which is moderately low. The company is retaining the remaining 72%. So it seems that Lonza Group is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, Lonza Group 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 20% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we are quite pleased with Lonza Group's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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