Is LeoVegas AB (publ)'s(STO:LEO) Recent Stock Performance Tethered To Its Strong Fundamentals?

Most readers would already be aware that LeoVegas' (STO:LEO) stock increased significantly by 29% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on LeoVegas' ROE.

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. 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 LeoVegas

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 LeoVegas is:

20% = €19m ÷ €98m (Based on the trailing twelve months to December 2020).

The 'return' refers to a company's earnings over the last year. That means that for every SEK1 worth of shareholders' equity, the company generated SEK0.20 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

LeoVegas' Earnings Growth And 20% ROE

To start with, LeoVegas' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 20%. Consequently, this likely laid the ground for the impressive net income growth of 21% seen over the past five years by LeoVegas. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between LeoVegas' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 21% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 LeoVegas is trading on a high P/E or a low P/E, relative to its industry.

Is LeoVegas Using Its Retained Earnings Effectively?

LeoVegas has a significant three-year median payout ratio of 68%, meaning the company only retains 32% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, LeoVegas is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 49% over the next three years. As a result, the expected drop in LeoVegas' payout ratio explains the anticipated rise in the company's future ROE to 39%, over the same period.

Conclusion

In total, we are pretty happy with LeoVegas' performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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. 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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