Should You Be Impressed By Lamb Weston Holdings, Inc.'s (NYSE:LW) ROE?

By
Simply Wall St
Published
April 11, 2022
NYSE:LW
Source: Shutterstock

While some investors are already well versed in financial metrics (hat tip), this article is for those who would like to learn about Return On Equity (ROE) and why it is important. By way of learning-by-doing, we'll look at ROE to gain a better understanding of Lamb Weston Holdings, Inc. (NYSE:LW).

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Lamb Weston Holdings

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 Lamb Weston Holdings is:

60% = US$234m ÷ US$392m (Based on the trailing twelve months to February 2022).

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 $0.60.

Does Lamb Weston Holdings Have A Good Return On Equity?

By comparing a company's ROE with its industry average, we can get a quick measure of how good it is. However, this method is only useful as a rough check, because companies do differ quite a bit within the same industry classification. Pleasingly, Lamb Weston Holdings has a superior ROE than the average (9.9%) in the Food industry.

roe
NYSE:LW Return on Equity April 11th 2022

That is a good sign. However, bear in mind that a high ROE doesn’t necessarily indicate efficient profit generation. Aside from changes in net income, a high ROE can also be the outcome of high debt relative to equity, which indicates risk. You can see the 3 risks we have identified for Lamb Weston Holdings by visiting our risks dashboard for free on our platform here.

How Does Debt Impact ROE?

Virtually all companies need money to invest in the business, to grow profits. The cash for investment can come from prior year profits (retained earnings), issuing new shares, or borrowing. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt required for growth will boost returns, but will not impact the shareholders' equity. In this manner the use of debt will boost ROE, even though the core economics of the business stay the same.

Lamb Weston Holdings' Debt And Its 60% ROE

We think Lamb Weston Holdings uses a significant amount of debt to maximize its returns, as it has a significantly higher debt to equity ratio of 6.94. So although the company has an impressive ROE, the company might not have been able to achieve this without the significant use of debt.

Conclusion

Return on equity is one way we can compare its business quality of different companies. Companies that can achieve high returns on equity without too much debt are generally of good quality. If two companies have around the same level of debt to equity, and one has a higher ROE, I'd generally prefer the one with higher ROE.

But when a business is high quality, the market often bids it up to a price that reflects this. Profit growth rates, versus the expectations reflected in the price of the stock, are a particularly important to consider. So you might want to take a peek at this data-rich interactive graph of forecasts for the company.

But note: Lamb Weston Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.

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