Most readers would already be aware that Lok'nStore Group's (LON:LOK) stock increased significantly by 21% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Specifically, we decided to study Lok'nStore Group's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Lok'nStore Group is:
2.5% = UK£3.0m ÷ UK£121m (Based on the trailing twelve months to July 2020).
The 'return' is the profit over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.02.
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. 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.
Lok'nStore Group's Earnings Growth And 2.5% ROE
As you can see, Lok'nStore Group's ROE looks pretty weak. Even compared to the average industry ROE of 8.5%, the company's ROE is quite dismal. Hence, the flat earnings seen by Lok'nStore Group over the past five years could probably be the result of it having a lower ROE.
As a next step, we compared Lok'nStore Group's net income growth with the industry and discovered that the industry saw an average growth of 2.5% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 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?
Lok'nStore Group has a high three-year median payout ratio of 99% (or a retention ratio of 1.1%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.
Additionally, Lok'nStore Group 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 90% of its profits over the next three years. 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.
In total, we would have a hard think before deciding on any investment action concerning 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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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