Jumbo Interactive Limited's (ASX:JIN) Stock Is Going Strong: Is the Market Following Fundamentals?

Most readers would already be aware that Jumbo Interactive's (ASX:JIN) stock increased significantly by 12% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Jumbo Interactive's ROE today.

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 Jumbo Interactive

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 Jumbo Interactive is:

35% = AU$28m ÷ AU$79m (Based on the trailing twelve months to December 2019).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.35 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Jumbo Interactive's Earnings Growth And 35% ROE

To begin with, Jumbo Interactive has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 8.8% which is quite remarkable. Under the circumstances, Jumbo Interactive's considerable five year net income growth of 51% was to be expected.

As a next step, we compared Jumbo Interactive'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 10%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Jumbo Interactive fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Jumbo Interactive Using Its Retained Earnings Effectively?

Jumbo Interactive has a significant three-year median payout ratio of 64%, meaning the company only retains 36% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Additionally, Jumbo Interactive has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 83% over the next three years. However, Jumbo Interactive's future ROE is expected to rise to 50% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

On the whole, we feel that Jumbo Interactive's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

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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.