LG Corp.'s (KRX:003550) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

LG (KRX:003550) has had a great run on the share market with its stock up by a significant 41% over the last three months. 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 LG'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for LG

How Is ROE Calculated?

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 LG is:

6.2% = ₩1.3t ÷ ₩21t (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. So, this means that for every ₩1 of its shareholder's investments, the company generates a profit of ₩0.06.

Why Is ROE Important For 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 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.

LG's Earnings Growth And 6.2% ROE

At first glance, LG's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 3.4% which we definitely can't overlook. Having said that, LG's net income growth over the past five years is more or less flat. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the flat earnings growth.

When you consider the fact that the industry earnings have shrunk at a rate of 6.5% in the same period, the company's net income growth is pretty remarkable.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is A003550 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is LG Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 29% (or a retention ratio of 71%), LG hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, LG 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 25% of its profits over the next three years. However, LG's ROE is predicted to rise to 8.4% despite there being no anticipated change in its payout ratio.

Summary

Overall, we are quite pleased with LG's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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