With its stock down 4.0% over the past month, it is easy to disregard LKQ (NASDAQ:LKQ). 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 LKQ'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

ROE 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 LKQ is:

12% = US$721m ÷ US$6.3b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.12 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 LKQ's Earnings Growth And 12% ROE

To begin with, LKQ seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 12%. This certainly adds some context to LKQ's moderate 9.4% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that LKQ's reported growth was lower than the industry growth of 22% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is LKQ fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is LKQ Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 27% (implying that the company retains 73% of its profits), it seems that LKQ is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, LKQ has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 33% over the next three years. However, LKQ's future ROE is expected to rise to 14% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

On the whole, we feel that LKQ's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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