Most readers would already be aware that Ralph Lauren's (NYSE:RL) stock increased significantly by 13% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Ralph Lauren's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Ralph Lauren

How Do You 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 Ralph Lauren is:

28% = US$705m ÷ US$2.5b (Based on the trailing twelve months to December 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 $0.28 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 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.

Ralph Lauren's Earnings Growth And 28% ROE

Firstly, we acknowledge that Ralph Lauren has a significantly high ROE. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. So, the substantial 25% net income growth seen by Ralph Lauren over the past five years isn't overly surprising.

We then performed a comparison between Ralph Lauren's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 22% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. What is RL worth today? The intrinsic value infographic in our free research report helps visualize whether RL is currently mispriced by the market.

Is Ralph Lauren Making Efficient Use Of Its Profits?

The three-year median payout ratio for Ralph Lauren is 35%, which is moderately low. The company is retaining the remaining 65%. By the looks of it, the dividend is well covered and Ralph Lauren is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Ralph Lauren has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 29%. Accordingly, forecasts suggest that Ralph Lauren's future ROE will be 33% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with Ralph Lauren's performance. 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.