Is Weakness In L'Oréal S.A. (EPA:OR) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 16% over the past three months, it is easy to disregard L'Oréal (EPA:OR). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for L'Oréal

How To Calculate Return On Equity?

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:

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

The 'return' is the profit 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 €0.22 in profit.

Why Is ROE Important For Earnings Growth?

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

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. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. This likely paved the way for the modest 14% net income growth seen by L'Oréal 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 3.2%.

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. What is OR worth today? The intrinsic value infographic in our free research report helps visualize whether OR is currently mispriced by the market.

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.

Additionally, L'Oréal 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 is expected to keep paying out approximately 56% of its profits over the next three years. Accordingly, forecasts suggest that L'Oréal's future ROE will be 21% which is again, similar to the current ROE.

Summary

On the whole, we feel that L'Oréal's performance has been quite good. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.