rhipe (ASX:RHP) has had a rough month with its share price down 11%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to rhipe’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 To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for rhipe is:
6.0% = AU$5.4m ÷ AU$90m (Based on the trailing twelve months to December 2020).
The ‘return’ refers to a company’s earnings over the last year. That means that for every A$1 worth of shareholders’ equity, the company generated A$0.06 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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.
rhipe’s Earnings Growth And 6.0% ROE
When you first look at it, rhipe’s ROE doesn’t look that attractive. Next, when compared to the average industry ROE of 11%, the company’s ROE leaves us feeling even less enthusiastic. In spite of this, rhipe was able to grow its net income considerably, at a rate of 43% in the last five years. Therefore, there could be other reasons behind this growth. Such as – high earnings retention or an efficient management in place.
As a next step, we compared rhipe’s net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 28%.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock’s future looks promising or ominous. Is RHP fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is rhipe Using Its Retained Earnings Effectively?
rhipe’s significant three-year median payout ratio of 57% (where it is retaining only 43% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.
Moreover, rhipe is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 53% of its profits over the next three years. Still, forecasts suggest that rhipe’s future ROE will rise to 14% even though the the company’s payout ratio is not expected to change by much.
In total, it does look like rhipe has some positive aspects to its business. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. We also studied the latest analyst forecasts and found that the company’s earnings growth is expected be similar to its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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.
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