Are LG Electronics Inc.'s (KRX:066570) Mixed Financials Driving The Negative Sentiment?

It is hard to get excited after looking at LG Electronics' (KRX:066570) recent performance, when its stock has declined 3.9% over the past week. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study LG Electronics' 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.

Check out our latest analysis for LG Electronics

How Do You 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 LG Electronics is:

4.9% = ₩1.1t ÷ ₩23t (Based on the trailing twelve months to December 2023).

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 ₩0.05.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

LG Electronics' Earnings Growth And 4.9% ROE

When you first look at it, LG Electronics' ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 5.5%, we may spare it some thought. Still, LG Electronics has seen a flat net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

We then compared LG Electronics' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.8% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 LG Electronics is trading on a high P/E or a low P/E, relative to its industry.

Is LG Electronics Efficiently Re-investing Its Profits?

LG Electronics' low three-year median payout ratio of 8.3%, (meaning the company retains92% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.

Moreover, LG Electronics has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 12% over the next three years. Still, forecasts suggest that LG Electronics' future ROE will rise to 11% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

On the whole, we feel that the performance shown by LG Electronics can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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.