Most readers would already be aware that Vista Group International's (NZSE:VGL) stock increased significantly by 42% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Vista Group International's ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To 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 Vista Group International is:
7.8% = NZ$13m ÷ NZ$164m (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.08 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. 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.
A Side By Side comparison of Vista Group International's Earnings Growth And 7.8% ROE
When you first look at it, Vista Group International's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. Therefore, Vista Group International's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
Next, on comparing with the industry net income growth, we found that Vista Group International's reported growth was lower than the industry growth of 24% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Vista Group International is trading on a high P/E or a low P/E, relative to its industry.
Is Vista Group International Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 47% (implying that the company keeps 53% of its income) over the last three years, Vista Group International has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 13% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
On the whole, we feel that the performance shown by Vista Group International 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.