With its stock down 7.6% over the past three months, it is easy to disregard Labcorp Holdings (NYSE:LH). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Labcorp Holdings' ROE today.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Do You 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 Labcorp Holdings is:
5.0% = US$400m ÷ US$8.0b (Based on the trailing twelve months to March 2024).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.05 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. 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.
A Side By Side comparison of Labcorp Holdings' Earnings Growth And 5.0% ROE
At first glance, Labcorp Holdings' ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 11%. Hence, the flat earnings seen by Labcorp Holdings over the past five years could probably be the result of it having a lower ROE.
Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 5.6% over the last few years.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Labcorp Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Labcorp Holdings Making Efficient Use Of Its Profits?
Despite having a moderate three-year median payout ratio of 33% (meaning the company retains67% of profits) in the last three-year period, Labcorp Holdings' earnings growth was more or les flat. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Only recently, Labcorp Holdings started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 17% over the next three years. As a result, the expected drop in Labcorp Holdings' payout ratio explains the anticipated rise in the company's future ROE to 16%, over the same period.
Conclusion
In total, we're a bit ambivalent about Labcorp Holdings' performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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.