With its stock down 12% over the past three months, it is easy to disregard Lok'nStore Group (LON:LOK). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. In this article, we decided to focus on Lok'nStore Group's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You 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 Lok'nStore Group is:
2.5% = UK£3.0m ÷ UK£121m (Based on the trailing twelve months to July 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.02 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of Lok'nStore Group's Earnings Growth And 2.5% ROE
It is hard to argue that Lok'nStore Group's ROE is much good in and of itself. Even when compared to the industry average of 6.8%, the ROE figure is pretty disappointing. As a result, Lok'nStore Group's flat earnings over the past five years doesn't come as a surprise given its lower ROE.
We then compared Lok'nStore Group's performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 2.9% in the same period. While this is not particularly good, its not particularly bad either.
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. 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 Lok'nStore Group is trading on a high P/E or a low P/E, relative to its industry.
Is Lok'nStore Group Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 99% (meaning, the company retains only 1.1% of profits) for Lok'nStore Group suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.
Moreover, Lok'nStore Group 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 90%. Still, forecasts suggest that Lok'nStore Group's future ROE will rise to 3.0% even though the the company's payout ratio is not expected to change by much.
Overall, we would be extremely cautious before making any decision on Lok'nStore Group. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. 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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