Most readers would already be aware that Locaweb Serviços de Internet’s (BVMF:LWSA3) stock increased significantly by 31% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company’s key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Locaweb Serviços de Internet’s 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. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
How Is ROE Calculated?
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 Locaweb Serviços de Internet is:
2.7% = R$18m ÷ R$657m (Based on the trailing twelve months to September 2020).
The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each R$1 of shareholders’ capital it has, the company made R$0.03 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Locaweb Serviços de Internet’s Earnings Growth And 2.7% ROE
It is quite clear that Locaweb Serviços de Internet’s ROE is rather low. Even compared to the average industry ROE of 5.5%, the company’s ROE is quite dismal. Despite this, surprisingly, Locaweb Serviços de Internet saw an exceptional 30% net income growth over the past five years. Therefore, there could be other reasons behind this growth. Such as – high earnings retention or an efficient management in place.
We then compared Locaweb Serviços de Internet’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 13% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. One 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 prospects. So, you may want to check if Locaweb Serviços de Internet is trading on a high P/E or a low P/E, relative to its industry.
Is Locaweb Serviços de Internet Efficiently Re-investing Its Profits?
The three-year median payout ratio for Locaweb Serviços de Internet is 40%, which is moderately low. The company is retaining the remaining 60%. By the looks of it, the dividend is well covered and Locaweb Serviços de Internet is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.
While Locaweb Serviços de Internet has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Existing analyst estimates suggest that the company’s future payout ratio is expected to drop to 17% over the next three years. The fact that the company’s ROE is expected to rise to 13% over the same period is explained by the drop in the payout ratio.
Overall, we feel that Locaweb Serviços de Internet certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. 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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