Lancaster Colony (NASDAQ:LANC) has had a rough week with its share price down 14%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Lancaster Colony's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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How Is ROE Calculated?

Return on equity 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 Lancaster Colony is:

17% = US$170m ÷ US$996m (Based on the trailing twelve months to March 2025).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.17.

View our latest analysis for Lancaster Colony

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Lancaster Colony's Earnings Growth And 17% ROE

To start with, Lancaster Colony's ROE looks acceptable. On comparing with the average industry ROE of 9.4% the company's ROE looks pretty remarkable. However, for some reason, the higher returns aren't reflected in Lancaster Colony's meagre five year net income growth average of 2.8%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

We then compared Lancaster Colony's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 11% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Lancaster Colony's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Lancaster Colony Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 74% (that is, the company retains only 26% of its income) over the past three years for Lancaster Colony suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

In addition, Lancaster Colony has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 57% over the next three years.

Conclusion

Overall, we feel that Lancaster Colony certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.