With its stock down 42% over the past three months, it is easy to disregard Wise (LON:WISE). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Wise's 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.
How Do You Calculate Return On Equity?
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 Wise is:
8.6% = UK£29m ÷ UK£339m (Based on the trailing twelve months to September 2021).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.09 in profit.
Why Is ROE Important For 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Wise's Earnings Growth And 8.6% ROE
At first glance, Wise's ROE doesn't look very promising. However, its ROE is similar to the industry average of 11%, so we won't completely dismiss the company. Moreover, we are quite pleased to see that Wise's net income grew significantly at a rate of 34% over the last five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Wise's growth is quite high when compared to the industry average growth of 26% in the same period, which is great to see.
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 Wise fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Wise Making Efficient Use Of Its Profits?
Wise doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.
Overall, we feel that Wise certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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.