Declining Stock and Solid Fundamentals: Is The Market Wrong About L'Oréal S.A. (EPA:OR)?

It is hard to get excited after looking at L'Oréal's (EPA:OR) recent performance, when its stock has declined 3.4% over the past three months. 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. Specifically, we decided to study L'Oréal's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for L'Oréal

How To 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 L'Oréal is:

22% = €6.5b ÷ €30b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.22.

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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of L'Oréal's Earnings Growth And 22% ROE

To begin with, L'Oréal has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. This probably laid the groundwork for L'Oréal's moderate 14% net income growth seen over the past five years.

As a next step, we compared L'Oréal'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 3.3%.

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. Has the market priced in the future outlook for OR? You can find out in our latest intrinsic value infographic research report.

Is L'Oréal Making Efficient Use Of 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.

Besides, L'Oréal has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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 55%. As a result, L'Oréal's ROE is not expected to change by much either, which we inferred from the analyst estimate of 21% for future ROE.

Summary

In total, we are pretty happy with L'Oréal's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.