Declining Stock and Solid Fundamentals: Is The Market Wrong About Legrand SA (EPA:LR)?

With its stock down 5.1% over the past three months, it is easy to disregard Legrand (EPA:LR). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Legrand's ROE.

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

View our latest analysis for Legrand

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Legrand is:

16% = €1.1b ÷ €6.8b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.16 in profit.

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. 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 Legrand's Earnings Growth And 16% ROE

At first glance, Legrand seems to have a decent ROE. Even when compared to the industry average of 15% the company's ROE looks quite decent. This certainly adds some context to Legrand's moderate 9.3% net income growth seen over the past five years.

As a next step, we compared Legrand'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 14% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is LR fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Legrand Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 47% (implying that the company retains 53% of its profits), it seems that Legrand is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Legrand 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 44%. Accordingly, forecasts suggest that Legrand's future ROE will be 16% which is again, similar to the current ROE.

Summary

On the whole, we feel that Legrand's performance has been quite good. 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 a good amount of 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 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.