Is Weakness In Littelfuse, Inc. (NASDAQ:LFUS) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 7.8% over the past three months, it is easy to disregard Littelfuse (NASDAQ:LFUS). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Littelfuse's ROE today.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Littelfuse

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 Littelfuse is:

14% = US$328m ÷ US$2.4b (Based on the trailing twelve months to July 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.14 in profit.

What Is The Relationship Between ROE And 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 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.

Littelfuse's Earnings Growth And 14% ROE

To start with, Littelfuse's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. This probably goes some way in explaining Littelfuse's significant 26% net income growth over the past five years amongst other factors. 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 compared Littelfuse's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 16% in the same 5-year period.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is LFUS fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Littelfuse Making Efficient Use Of Its Profits?

Littelfuse's three-year median payout ratio to shareholders is 17%, which is quite low. This implies that the company is retaining 83% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Littelfuse is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 15%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 14%.

Summary

On the whole, we feel that Littelfuse's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.