James Latham plc's (LON:LTHM) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

James Latham (LON:LTHM) has had a great run on the share market with its stock up by a significant 6.9% over the last month. 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. In this article, we decided to focus on James Latham's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for James Latham

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 James Latham is:

10.0% = UK£11m ÷ UK£109m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.10 in profit.

What Is The Relationship Between ROE And 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.

James Latham's Earnings Growth And 10.0% ROE

At first glance, James Latham seems to have a decent ROE. Even so, when compared with the average industry ROE of 15%, we aren't very excited. Further, James Latham's five year net income growth of 4.2% is on the lower side. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. Hence there might be some other aspects that are keeping growth in earnings low. Such as, the company pays out a huge portion of its earnings as dividends, or is facing competitive pressures.

Next, on comparing with the industry net income growth, we found that James Latham's reported growth was lower than the industry growth of 10% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if James Latham is trading on a high P/E or a low P/E, relative to its industry.

Is James Latham Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 27% (implying that the company retains the remaining 73% of its income), James Latham's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, James Latham 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.

Summary

On the whole, we do feel that James Latham has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth.

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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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