Does the recent performance of the Leonardo Spa (BIT:LDO) stock reflect its financial health?

Most readers will already know that Leonardo (BIT:LDO) stock is up 5.7% over the past three months. Given that the market rewards strong long-term financials, we wonder if this is the case in this case. In particular, we will pay attention to Leonardo’s ROE today.

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

See our latest analysis for Leonardo

How to calculate return on equity?

The ROE formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

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

10% = €663 million ÷ €6.5 billion (based on the last twelve months to March 2022).

The “yield” is the profit of the last twelve months. This therefore means that for each €1 of investment by its shareholder, the company generates a profit of €0.10.

What does ROE have to do with earnings growth?

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

Leonardo earnings growth and ROE of 10%

For starters, Leonardo’s ROE seems acceptable. Still, the fact that the company’s ROE is below the industry average of 13% tempers our expectations. However, we can see that Leonardo has experienced a modest net income growth of 5.5% over the past five years. We believe there could be other factors at play here. For example, the business has a low payout ratio or is efficiently managed. However, it’s worth remembering that the company has a decent ROE to start with, just that it’s below the industry average. So this also provides some context for the earnings growth the company is seeing.

As a next step, we compared Leonardo’s net income growth with the industry and found that the company has a similar growth figure compared to the industry average growth rate of 6.3% during of the same period.

BIT:LDO Past Earnings Growth July 4, 2022

The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. By doing so, they will get an idea if the stock is headed for clear blue waters or if swampy waters are waiting. A 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 outlook. Thus, you might want to check whether Leonardo is trading on a high P/E or on a low P/E, relative to its industry.

Does Leonardo use his profits efficiently?

Leonardo has a low three-year median payout ratio of 14%, which means the company keeps the remaining 86% of its profits. This suggests that the management reinvests most of the profits to grow the business.

Additionally, Leonardo paid dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders. After reviewing the latest analyst consensus data, we found that the company’s future payout ratio is expected to drop to 11% over the next three years. However, the company’s ROE is not expected to change much despite the lower expected payout ratio.

Conclusion

Overall, we’re pretty happy with Leonardo’s performance. In particular, it is good to see that the company has seen significant earnings growth supported by a respectable ROE and a high reinvestment rate. That said, the latest forecasts from industry analysts show that the company’s earnings are set to accelerate. Are these analyst expectations based on general industry expectations or company fundamentals? Click here to access our analyst forecast page for the company.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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