Has LSI Software S.A.'s (WSE:LSI) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Most readers would already be aware that LSI Software's (WSE:LSI) stock increased significantly by 11% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study LSI Software'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 LSI Software

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 LSI Software is:

9.9% = zł4.0m ÷ zł40m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every PLN1 worth of shareholders' equity, the company generated PLN0.10 in profit.

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 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.

LSI Software's Earnings Growth And 9.9% ROE

When you first look at it, LSI Software's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 24%. Although, we can see that LSI Software saw a modest net income growth of 9.7% over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that LSI Software's reported growth was lower than the industry growth of 17% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about LSI Software's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is LSI Software Making Efficient Use Of Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

Overall, we feel that LSI Software certainly does have some positive factors to consider. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for LSI Software by visiting our risks dashboard for free on our platform here.

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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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