Lincoln Electric Holdings (NASDAQ:LECO) has had a rough month with its share price down 4.8%. However, the company’s fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Lincoln Electric Holdings’ ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company’s success at turning shareholder investments into profits.
See our latest analysis for Lincoln Electric Holdings
How Do You 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 Lincoln Electric Holdings is:
31% = US$267m ÷ US$858m (Based on the trailing twelve months to September 2021).
The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.31 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. 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.
A Side By Side comparison of Lincoln Electric Holdings’ Earnings Growth And 31% ROE
To begin with, Lincoln Electric Holdings has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 13% the company’s ROE is quite impressive. However, for some reason, the higher returns aren’t reflected in Lincoln Electric Holdings’ meagre five year net income growth average of 3.0%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn’t been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that Lincoln Electric Holdings’ reported growth was lower than the industry growth of 8.5% 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. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is LECO worth today? The intrinsic value infographic in our free research report helps visualize whether LECO is currently mispriced by the market.
Is Lincoln Electric Holdings Efficiently Re-investing Its Profits?
Despite having a moderate three-year median payout ratio of 42% (implying that the company retains the remaining 58% of its income), Lincoln Electric Holdings’ earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Lincoln Electric Holdings has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Existing analyst estimates suggest that the company’s future payout ratio is expected to drop to 28% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 43%, over the same period.
Conclusion
On the whole, we do feel that Lincoln Electric Holdings has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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