Lontium Semiconductor (SHSE:688486) has had a rough week with its share price down 8.9%. 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 Lontium Semiconductor'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Lontium Semiconductor is:

8.8% = CN¥126m ÷ CN¥1.4b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Lontium Semiconductor's Earnings Growth And 8.8% ROE

When you first look at it, Lontium Semiconductor's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 5.7%, is definitely interesting. Even more so after seeing Lontium Semiconductor's exceptional 23% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So, there might well be other reasons for the earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.

As a next step, we compared Lontium Semiconductor's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 20% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Lontium Semiconductor fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Lontium Semiconductor Making Efficient Use Of Its Profits?

Lontium Semiconductor has a three-year median payout ratio of 33% (where it is retaining 67% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Lontium Semiconductor is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

While Lontium Semiconductor has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 21% over the next three years. As a result, the expected drop in Lontium Semiconductor's payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.

Conclusion

Overall, we are quite pleased with Lontium Semiconductor's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.