Is Lenovo Group Limited's (HKG:992) Recent Stock Performance Tethered To Its Strong Fundamentals?

Lenovo Group (HKG:992) has had a great run on the share market with its stock up by a significant 13% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Lenovo Group's ROE in this article.

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

Check out our latest analysis for Lenovo Group

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 Lenovo Group is:

16% = US$955m ÷ US$6.1b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each HK$1 of shareholders' capital it has, the company made HK$0.16 in profit.

What Has ROE Got To Do With 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Lenovo Group's Earnings Growth And 16% ROE

To start with, Lenovo Group's ROE looks acceptable. On comparing with the average industry ROE of 9.1% the company's ROE looks pretty remarkable. This certainly adds some context to Lenovo Group's decent 19% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Lenovo Group's growth is quite high when compared to the industry average growth of 1.3% in the same period, which is great to see.

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). This then helps them determine if the stock is placed for a bright or bleak future. Is Lenovo Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Lenovo Group Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 32% (implying that the company retains 68% of its profits), it seems that Lenovo Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Lenovo Group is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. 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 30%. However, Lenovo Group's ROE is predicted to rise to 24% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we feel that Lenovo Group's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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.