Has London Security plc (LON:LSC) Stock's Recent Performance Got Anything to Do With Its Financial Health?

London Security's (LON:LSC) stock up by 9.5% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on London Security's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for London Security

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 London Security is:

12% = UK£15m ÷ UK£124m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £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. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of London Security's Earnings Growth And 12% ROE

At first glance, London Security seems to have a decent ROE. On comparing with the average industry ROE of 8.8% the company's ROE looks pretty remarkable. This certainly adds some context to London Security's decent 6.3% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that London Security's reported growth was lower than the industry growth of 8.0% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about London Security's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is London Security Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 60% (or a retention ratio of 40%) for London Security suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, London Security 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.

Summary

Overall, we feel that London Security certainly does have some positive factors to consider. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. Up till now, we've only made a short study of the company's growth data. You can do your own research on London Security and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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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