Is LG Electronics Inc.’s (KRX:066570) Recent Price Movement Underpinned By Its Weak Fundamentals?

LG Electronics (KRX:066570) has had a rough month with its share price down 13%. We, however decided to study the company’s financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company’s financials. Specifically, we decided to study LG Electronics’ ROE in this article.

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. Put another way, it reveals the company’s success at turning shareholder investments into profits.

Check out our latest analysis for LG Electronics

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 LG Electronics is:

6.6% = ₩1.6t ÷ ₩24t (Based on the trailing twelve months to June 2024).

The ‘return’ is the income the business earned over the last year. That means that for every ₩1 worth of shareholders’ equity, the company generated ₩0.07 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.

LG Electronics’ Earnings Growth And 6.6% ROE

At first glance, LG Electronics’ ROE doesn’t look very promising. Yet, a closer study shows that the company’s ROE is similar to the industry average of 7.0%. But then again, LG Electronics’ five year net income shrunk at a rate of 3.8%. Remember, the company’s ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared LG Electronics’ growth with the industry we found that while the company’s earnings have been shrinking, the industry has seen an earnings growth of 9.6% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. If you’re wondering about LG Electronics”s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is LG Electronics Using Its Retained Earnings Effectively?

LG Electronics’ low three-year median payout ratio of 9.4% (implying that it retains the remaining 91% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, LG Electronics has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to rise to 13% over the next three years. However, LG Electronics’ future ROE is expected to rise to 11% 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 the performance shown by LG Electronics can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company’s earnings growth rate. 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.