Lovisa Holdings (ASX:LOV) had a tough three months with its share price down 25%. It seems that the market has completely ignored the positive aspects of the company’s fundamentals and decided to weigh more on the negatives. Stock prices are usually determined by a company’s financial performance over the long term, and so we decided to pay more attention to the company’s financial performance. In this article, we decided to focus on the ROE of Lovisa Holdings.
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.
See our latest analysis for Lovisa Holdings
How is ROE calculated?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE of Lovisa Holdings is:
66% = AU$41 million ÷ AU$63 million (based on trailing 12 months to December 2021).
The “yield” is the profit of the last twelve months. This means that for every Australian dollar of equity, the company generated a profit of 0.66 Australian dollars.
Why is ROE important for earnings growth?
So far, we have learned that ROE measures how efficiently a company generates its profits. We now need to assess how much profit the company is reinvesting or “retaining” for future growth, which then gives us an idea of the company’s growth potential. Assuming all else is equal, companies that have both a higher return on equity and better earnings retention are generally the ones with a higher growth rate compared to companies that don’t. same characteristics.
Lovisa Holdings earnings growth and ROE of 66%
For starters, Lovisa Holdings has a pretty high ROE, which is interesting. Second, a comparison to the average industry-reported ROE of 21% also does not go unnoticed by us. Needless to say, we are quite surprised to see that Lovisa Holdings’ net profit has declined by 6.4% over the past five years. We feel there could be other factors at play here that are preventing the company from growing. These include poor revenue retention or poor capital allocation.
So, as a next step, we benchmarked Lovisa Holdings’ performance against the industry and were disappointed to find that while the company was cutting profits, the industry was increasing profits at a rate of 18% in during the same period.
Earnings growth is an important factor in stock valuation. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. This will help them determine if the future of the title looks bright or ominous. A 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 outlook. So, you might want to check if Lovisa Holdings is trading on a high P/E or a low P/E, relative to its industry.
Does Lovisa Holdings Use Retained Earnings Effectively?
With a three-year median payout ratio hitting 142%, Lovisa Holdings’ earnings decline comes as no surprise as the company pays a dividend that is beyond its means. Paying a dividend higher than reported earnings is not a sustainable decision. Our risk dashboard should have the 2 risks we identified for Lovisa Holdings.
Additionally, Lovisa Holdings has paid dividends over a seven-year period, meaning the company’s management is instead focused on maintaining its dividend payouts regardless of declining earnings. Existing analyst estimates suggest the company’s future payout ratio is likely to drop to 72% over the next three years. As a result, the expected decline in Lovisa Holdings’ payout ratio explains the company’s expected future ROE rise to 94% over the same period.
All in all, we are a little mixed on the performance of Lovisa Holdings. Although the company has a high rate of return, its low earnings retention is likely what is hindering its earnings growth. That said, we have studied the latest analyst forecasts and found that although the company has cut earnings in the past, analysts expect earnings to increase in the future. To learn more about the latest analyst forecasts for the company, check out this analyst forecast visualization for the company.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.