Are Poor Financial Prospects Dragging Down Lancashire Holdings Limited (LON:LRE Stock?

By
Simply Wall St
Published
October 22, 2021
LSE:LRE
Source: Shutterstock

Lancashire Holdings (LON:LRE) has had a rough three months with its share price down 22%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Lancashire Holdings' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Lancashire Holdings

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 Lancashire Holdings is:

5.0% = US$78m ÷ US$1.6b (Based on the trailing twelve months to June 2021).

The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.05 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 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.

Lancashire Holdings' Earnings Growth And 5.0% ROE

On the face of it, Lancashire Holdings' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 13% either. Therefore, it might not be wrong to say that the five year net income decline of 19% seen by Lancashire Holdings was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 2.8% in the same period, we still found Lancashire Holdings' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

past-earnings-growth
LSE:LRE Past Earnings Growth October 22nd 2021

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for LRE? You can find out in our latest intrinsic value infographic research report.

Is Lancashire Holdings Efficiently Re-investing Its Profits?

Lancashire Holdings' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 65% (or a retention ratio of 35%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 2 risks we have identified for Lancashire Holdings.

Additionally, Lancashire Holdings has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no 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 70%. However, Lancashire Holdings' ROE is predicted to rise to 14% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, Lancashire Holdings' performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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Simply Wall St

Simply Wall St is focused on providing unbiased, high-quality research coverage on every listed company in the world. Our research team consists of data scientists and multiple equity analysts with over two decades worth of financial markets experience between them.