Stock Analysis

Has L'Air Liquide S.A.'s (EPA:AI) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

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L'Air Liquide's (EPA:AI) stock is up by a considerable 12% 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'Air Liquide's ROE in this article.

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.

Our analysis indicates that AI is potentially overvalued!

How Do You 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'Air Liquide is:

12% = €2.8b ÷ €24b (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.12 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. 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.

L'Air Liquide's Earnings Growth And 12% ROE

At first glance, L'Air Liquide seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 9.8%. Despite the moderate return on equity, L'Air Liquide has posted a net income growth of 4.8% over the past five years. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that L'Air Liquide's reported growth was lower than the industry growth of 8.8% in the same period, which is not something we like to see.

past-earnings-growth
ENXTPA:AI Past Earnings Growth December 3rd 2022

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. If you're wondering about L'Air Liquide's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is L'Air Liquide Making Efficient Use Of Its Profits?

L'Air Liquide has a three-year median payout ratio of 53% (implying that it keeps only 47% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Moreover, L'Air Liquide has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. 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 47%. Regardless, the future ROE for L'Air Liquide is predicted to rise to 15% despite there being not much change expected in its payout ratio.

Conclusion

In total, it does look like L'Air Liquide has some positive aspects to its business. 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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