Most readers would already be aware that Kathmandu Holdings' (NZSE:KMD) stock increased significantly by 13% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Kathmandu 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Kathmandu Holdings is:
1.1% = NZ$8.9m ÷ NZ$779m (Based on the trailing twelve months to July 2020).
The 'return' refers to a company's earnings over the last year. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.01 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
A Side By Side comparison of Kathmandu Holdings' Earnings Growth And 1.1% ROE
It is hard to argue that Kathmandu Holdings' ROE is much good in and of itself. Even when compared to the industry average of 13%, the ROE figure is pretty disappointing. However, the moderate 8.2% net income growth seen by Kathmandu Holdings over the past five years is definitely a positive. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Kathmandu Holdings' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 7.2% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for KMD? You can find out in our latest intrinsic value infographic research report.
Is Kathmandu Holdings Using Its Retained Earnings Effectively?
While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.
Our latest analyst data shows that the future payout ratio of the company is expected to rise to 85% over the next three years. Regardless, the future ROE for Kathmandu Holdings is speculated to rise to 11% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
In total, it does look like Kathmandu Holdings has some positive aspects to its business. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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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