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El Pollo Loco Holdings, Inc.'s (NASDAQ:LOCO) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

With its stock down 8.5% over the past three months, it is easy to disregard El Pollo Loco Holdings (NASDAQ:LOCO). 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 El Pollo Loco Holdings' 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.

See our latest analysis for El Pollo Loco Holdings

How Is ROE Calculated?

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 El Pollo Loco Holdings is:

9.3% = US$28m ÷ US$304m (Based on the trailing twelve months to September 2021).

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 $0.09.

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. 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.

El Pollo Loco Holdings' Earnings Growth And 9.3% ROE

When you first look at it, El Pollo Loco Holdings' ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 16%. Although, we can see that El Pollo Loco Holdings saw a modest net income growth of 16% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

When you consider the fact that the industry earnings have shrunk at a rate of 2.2% in the same period, the company's net income growth is pretty remarkable.

past-earnings-growth
past-earnings-growth

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about El Pollo Loco Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is El Pollo Loco Holdings Using Its Retained Earnings Effectively?

El Pollo Loco Holdings doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the decent earnings growth number that we discussed above.

Conclusion

On the whole, we do feel that El Pollo Loco Holdings has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

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

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.

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