With its stock down 8.1% over the past month, it is easy to disregard Lennar (NYSE:LEN). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Lennar’s ROE.
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.
How To Calculate Return On Equity?
Return on equity 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 Lennar is:
20% = US$4.4b ÷ US$22b (Based on the trailing twelve months to May 2022).
The ‘return’ is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders’ equity, the company generated $0.20 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
Lennar’s Earnings Growth And 20% ROE
To start with, Lennar’s ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 22%. Consequently, this likely laid the ground for the impressive net income growth of 33% seen over the past five years by Lennar. However, there could also be other drivers behind this growth. Such as – high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Lennar’s growth is quite high when compared to the industry average growth of 27% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is LEN worth today? The intrinsic value infographic in our free research report helps visualize whether LEN is currently mispriced by the market.
Is Lennar Efficiently Re-investing Its Profits?
Lennar has a really low three-year median payout ratio of 7.0%, meaning that it has the remaining 93% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Additionally, Lennar has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 12% over the next three years. Therefore, the expected rise in the payout ratio explains why the company’s ROE is expected to decline to 13% over the same period.
In total, we are pretty happy with Lennar’s performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, according to the latest industry analyst forecasts, the company’s earnings are expected to shrink in the future. 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. 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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