Could The Market Be Wrong About L'Oréal S.A. (EPA:OR) Given Its Attractive Financial Prospects?

L'Oréal (EPA:OR) has had a rough month with its share price down 9.3%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on L'Oréal's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for L'Oréal

How Is ROE Calculated?

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 L'Oréal is:

21% = €6.2b ÷ €29b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.21 in profit.

What Has ROE Got To Do With 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.

L'Oréal's Earnings Growth And 21% ROE

Firstly, we acknowledge that L'Oréal has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. Probably as a result of this, L'Oréal was able to see a decent net income growth of 12% over the last five years.

Next, on comparing with the industry net income growth, we found that L'Oréal's growth is quite high when compared to the industry average growth of 3.2% in the same period, which is great to see.

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

Is L'Oréal Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 55% (or a retention ratio of 45%) for L'Oréal suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, L'Oréal is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 54%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 22%.

Summary

In total, we are pretty happy with L'Oréal's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com