It is hard to get excited after looking at Longhorn Auto's (SZSE:301488) recent performance, when its stock has declined 13% over the past month. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Longhorn Auto's 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.

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 Longhorn Auto is:

9.2% = CN¥116m ÷ CN¥1.3b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CN¥1 of shareholders' capital it has, the company made CN¥0.09 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.

Longhorn Auto's Earnings Growth And 9.2% ROE

On the face of it, Longhorn Auto's ROE is not much to talk about. However, its ROE is similar to the industry average of 8.1%, so we won't completely dismiss the company. Looking at Longhorn Auto's exceptional 21% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving 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.

Next, on comparing with the industry net income growth, we found that Longhorn Auto's growth is quite high when compared to the industry average growth of 8.4% in the same period, which is great to see.

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. 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 Longhorn Auto is trading on a high P/E or a low P/E, relative to its industry.

Is Longhorn Auto Using Its Retained Earnings Effectively?

Longhorn Auto has a significant three-year median payout ratio of 61%, meaning the company only retains 39% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Along with seeing a growth in earnings, Longhorn Auto only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Summary

In total, it does look like Longhorn Auto has some positive aspects to its business. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Longhorn Auto's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com