Are Strong Financial Prospects The Force That Is Driving The Momentum In Leonardo S.p.a.'s BIT:LDO) Stock?

Leonardo (BIT:LDO) has had a great run on the share market with its stock up by a significant 10% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Leonardo's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Leonardo

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 Leonardo is:

12% = €898m ÷ €7.7b (Based on the trailing twelve months to March 2023).

The 'return' is the yearly profit. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.12.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Leonardo's Earnings Growth And 12% ROE

To start with, Leonardo's ROE looks acceptable. Even when compared to the industry average of 13% the company's ROE looks quite decent. This certainly adds some context to Leonardo's moderate 18% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Leonardo's growth is quite high when compared to the industry average growth of 9.0% 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). Doing so will help them establish if the stock's future looks promising or ominous. What is LDO worth today? The intrinsic value infographic in our free research report helps visualize whether LDO is currently mispriced by the market.

Is Leonardo Making Efficient Use Of Its Profits?

Leonardo's three-year median payout ratio to shareholders is 12% (implying that it retains 88% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Leonardo is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 9.3% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Summary

Overall, we are quite pleased with Leonardo's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.