Are Poor Financial Prospects Dragging Down LondonMetric Property Plc (LON:LMP Stock?

With its stock down 6.3% over the past three months, it is easy to disregard LondonMetric Property (LON:LMP). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on LondonMetric Property'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for LondonMetric Property

How Is ROE Calculated?

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 LondonMetric Property is:

5.6% = UK£89m ÷ UK£1.6b (Based on the trailing twelve months to September 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 £0.06 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

LondonMetric Property's Earnings Growth And 5.6% ROE

When you first look at it, LondonMetric Property's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 5.7%, we may spare it some thought. But then again, LondonMetric Property's five year net income shrunk at a rate of 8.0%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared LondonMetric Property's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 12% in the same period.

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. 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 LondonMetric Property is trading on a high P/E or a low P/E, relative to its industry.

Is LondonMetric Property Using Its Retained Earnings Effectively?

LondonMetric Property has a very high three-year median payout ratio of 100%, implying that it retains only 0.3% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. So this probably explains the company's shrinking earnings.

Additionally, LondonMetric Property 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 103%. As a result, LondonMetric Property's ROE is not expected to change by much either, which we inferred from the analyst estimate of 5.4% for future ROE.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning LondonMetric Property. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. 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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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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