L'Oréal S.A.'s (EPA:OR) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

L'Oréal's (EPA:OR) stock is up by a considerable 11% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. 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?

ROE 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:

11% = €3.2b ÷ €29b (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.11 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. 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. 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 11% ROE

To begin with, L'Oréal seems to have a respectable ROE. Even when compared to the industry average of 11% the company's ROE looks quite decent. Despite the modest returns, L'Oréal's five year net income growth was quite low, averaging at only 4.8%. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that L'Oréal's reported growth was lower than the industry growth of 6.5% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is L'Oréal fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is L'Oréal Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 55% (or a retention ratio of 45%), most of L'Oréal's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

In addition, L'Oréal 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 57%. Regardless, the future ROE for L'Oréal is predicted to rise to 15% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we feel that L'Oréal certainly does have some positive factors to consider. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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.
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