Does Lena Lighting S.A.'s (WSE:LEN) Weak Fundamentals Mean That The Stock Could Move In The Opposite Direction?

Most readers would already know that Lena Lighting's (WSE:LEN) stock increased by 5.2% over the past three months. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. Specifically, we decided to study Lena Lighting's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Lena Lighting

How To Calculate Return On Equity?

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 Lena Lighting is:

7.2% = zł6.7m ÷ zł93m (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 PLN1 of its shareholder's investments, the company generates a profit of PLN0.07.

Why Is ROE Important For 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.

Lena Lighting's Earnings Growth And 7.2% ROE

When you first look at it, Lena Lighting's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 9.6% either. For this reason, Lena Lighting's five year net income decline of 8.5% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared Lena Lighting's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 26% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Lena Lighting is trading on a high P/E or a low P/E, relative to its industry.

Is Lena Lighting Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 96% (implying that 4.3% of the profits are retained), most of Lena Lighting's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 3 risks we have identified for Lena Lighting visit our risks dashboard for free.

Moreover, Lena Lighting 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.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Lena Lighting. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Lena Lighting's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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