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Eureka Group Holdings Limited's (ASX:EGH) Has Performed Well But Fundamentals Look Varied: Is There A Clear Direction For The Stock?

·4-min read

Most readers would already know that Eureka Group Holdings' (ASX:EGH) stock increased by 6.9% over the past three months. Given that the stock prices usually follow long-term business performance, we wonder if the company's mixed financials could have any adverse effect on its current price price movement Particularly, we will be paying attention to Eureka Group Holdings' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Eureka Group Holdings

How Do You Calculate Return On Equity?

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 Eureka Group Holdings is:

6.9% = AU$6.3m ÷ AU$91m (Based on the trailing twelve months to June 2021).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.07 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Eureka Group Holdings' Earnings Growth And 6.9% ROE

On the face of it, Eureka Group Holdings' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.0%. Having said that, Eureka Group Holdings' five year net income decline rate was 4.7%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

Next, on comparing with the industry net income growth, we found that Eureka Group Holdings' earnings seems to be shrinking at a similar rate as the industry which shrunk at a rate of a rate of 5.6% in the same period.

past-earnings-growth
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Eureka Group Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Eureka Group Holdings Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 39% (that is, a retention ratio of 61%), the fact that Eureka Group Holdings' earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Eureka Group Holdings only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 41% of its profits over the next three years. However, Eureka Group Holdings' ROE is predicted to rise to 9.0% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that the performance shown by Eureka Group Holdings can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.

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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