It is hard to get excited after looking at Littelfuse's (NASDAQ:LFUS) recent performance, when its stock has declined 3.1% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Littelfuse's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Littelfuse is:

7.6% = US$195m ÷ US$2.6b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.08 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.

Littelfuse's Earnings Growth And 7.6% ROE

When you first look at it, Littelfuse's ROE doesn't look that attractive. 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 10%. Littelfuse was still able to see a decent net income growth of 14% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Littelfuse's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 14% in the same 5-year period.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is LFUS fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Littelfuse Efficiently Re-investing Its Profits?

In Littelfuse's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 18% (or a retention ratio of 82%), which suggests that the company is investing most of its profits to grow its business.

Besides, Littelfuse has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 21%. Still, forecasts suggest that Littelfuse's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, it does look like Littelfuse has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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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.