With its stock down 1.8% over the past week, it is easy to disregard Littelfuse (NASDAQ:LFUS). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Littelfuse's ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 Littelfuse is:

10% = US$259m ÷ US$2.5b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.10 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. 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. 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.

Littelfuse's Earnings Growth And 10% ROE

To start with, Littelfuse's ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 22% seen over the past five years by Littelfuse. However, there could also be other drivers behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Littelfuse's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 14%.

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. Has the market priced in the future outlook for LFUS? You can find out in our latest intrinsic value infographic research report.

Is Littelfuse Using Its Retained Earnings Effectively?

Littelfuse's three-year median payout ratio to shareholders is 17%, which is quite low. This implies that the company is retaining 83% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, Littelfuse is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 16% of its profits over the next three years. Regardless, the future ROE for Littelfuse is predicted to rise to 13% despite there being not much change expected in its payout ratio.

Summary

On the whole, we feel that Littelfuse's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.