Linedata Services S.A.'s (EPA:LIN) Stock Is Going Strong: Have Financials A Role To Play?

Most readers would already be aware that Linedata Services' (EPA:LIN) stock increased significantly by 49% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Linedata Services' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Linedata Services

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 Linedata Services is:

15% = €17m ÷ €117m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.15 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. 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.

Linedata Services' Earnings Growth And 15% ROE

At first glance, Linedata Services seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 9.1%. For this reason, Linedata Services' five year net income decline of 6.5% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared Linedata Services' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.2% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is LIN worth today? The intrinsic value infographic in our free research report helps visualize whether LIN is currently mispriced by the market.

Is Linedata Services Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 45% (where it is retaining 55% of its profits), Linedata Services has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Linedata Services 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 46%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 15%.

Summary

On the whole, we do feel that Linedata Services has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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