Lifestyle Communities (ASX:LIC) has had a rough three months with its share price down 15%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Lifestyle Communities'  ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Lifestyle Communities

How Do You 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 Lifestyle Communities is:

26% = AU$105m ÷ AU$400m (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.26.

What Has ROE Got To Do With 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. 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.

Lifestyle Communities' Earnings Growth And 26% ROE

First thing first, we like that Lifestyle Communities has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 7.4% also doesn't go unnoticed by us. So, the substantial 22% net income growth seen by Lifestyle Communities over the past five years isn't overly surprising.

When you consider the fact that the industry earnings have shrunk at a rate of 10% in the same period, the company's net income growth is pretty remarkable.

 past-earnings-growth

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. One 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 prospects. So, you may want to check if Lifestyle Communities is trading on a high P/E or a low P/E, relative to its industry.

Is Lifestyle Communities Using Its Retained Earnings Effectively?

Lifestyle Communities' three-year median payout ratio to shareholders is 11%, which is quite low. This implies that the company is retaining 89% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Lifestyle Communities is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 20% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 6.8% over the same period.

Conclusion

On the whole, we feel that Lifestyle Communities' 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 substantial growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the company's future earnings growth forecasts take a look at this freereport 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.