Lennar (NYSE:LEN) has had a rough three months with its share price down 14%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Lennar's ROE.

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 Lennar

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 Lennar is:

15% = US$4.2b ÷ US$27b (Based on the trailing twelve months to May 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.15 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. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Lennar's Earnings Growth And 15% ROE

At first glance, Lennar seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 15%. Consequently, this likely laid the ground for the decent growth of 17% seen over the past five years by Lennar.

As a next step, we compared Lennar's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 24% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for LEN? You can find out in our latest intrinsic value infographic research report.

Is Lennar Efficiently Re-investing Its Profits?

In Lennar's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 9.3% (or a retention ratio of 91%), which suggests that the company is investing most of its profits to grow its business.

Additionally, Lennar has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 12% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

On the whole, we feel that Lennar's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com