With its stock down 13% over the past three months, it is easy to disregard Lynch Group Holdings (ASX:LGL). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Lynch Group Holdings' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Lynch Group Holdings

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 Lynch Group Holdings is:

4.2% = AU$9.9m ÷ AU$239m (Based on the trailing twelve months to July 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.04 in profit.

What Has ROE Got To Do With 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. 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.

Lynch Group Holdings' Earnings Growth And 4.2% ROE

On the face of it, Lynch Group Holdings' ROE is not much to talk about. Next, when compared to the average industry ROE of 6.1%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 6.9% seen by Lynch Group Holdings over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared Lynch Group Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.9% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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. Is Lynch Group Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Lynch Group Holdings Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 85% (implying that 15% of the profits are retained), most of Lynch Group Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Lynch Group Holdings by visiting our risks dashboard for free on our platform here.

Only recently, Lynch Group Holdings stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 64% over the next three years. As a result, the expected drop in Lynch Group Holdings' payout ratio explains the anticipated rise in the company's future ROE to 12%, over the same period.

Summary

On the whole, Lynch Group Holdings' performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow 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.