Has Lechwerke AG (FRA:LEC) Stock's Recent Performance Got Anything to Do With Its Financial Health?

By
Simply Wall St
Published
April 10, 2022
DB:LEC
Source: Shutterstock

Most readers would already know that Lechwerke's (FRA:LEC) stock increased by 4.2% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Lechwerke's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Lechwerke

How Do You Calculate Return On Equity?

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 Lechwerke is:

19% = €111m ÷ €572m (Based on the trailing twelve months to December 2021).

The 'return' is the profit over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.19.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Lechwerke's Earnings Growth And 19% ROE

To start with, Lechwerke's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 8.5%. Yet, Lechwerke has posted measly growth of 2.6% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Lechwerke'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 5.8% in the same period.

past-earnings-growth
DB:LEC Past Earnings Growth April 10th 2022

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. 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 Lechwerke is trading on a high P/E or a low P/E, relative to its industry.

Is Lechwerke Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 85% (or a retention ratio of 15%), most of Lechwerke's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

In addition, Lechwerke has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

In total, it does look like Lechwerke has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 1 risk we have identified for Lechwerke visit our risks dashboard for free.

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