Most readers would already be aware that Adecco Group's (VTX:ADEN) stock increased significantly by 19% over the past week. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Adecco Group's ROE in this article.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Adecco Group is:
8.9% = €324m ÷ €3.7b (Based on the trailing twelve months to September 2023).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CHF1 of shareholders' capital it has, the company made CHF0.09 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. 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 Adecco Group's Earnings Growth And 8.9% ROE
At first glance, Adecco Group seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 13% does temper our expectations. Further research shows that Adecco Group's net income has shrunk at a rate of 5.8% over the last five years. Not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. Therefore, the shrinking earnings could be the result of other factors. These include low earnings retention or poor allocation of capital.
However, when we compared Adecco Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is ADEN worth today? The intrinsic value infographic in our free research report helps visualize whether ADEN is currently mispriced by the market.
Is Adecco Group Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 71% (implying that 29% of the profits are retained), most of Adecco Group's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 5 risks we have identified for Adecco Group visit our risks dashboard for free.
Moreover, Adecco Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 70%. However, Adecco Group's ROE is predicted to rise to 15% despite there being no anticipated change in its payout ratio.
On the whole, we feel that the performance shown by Adecco Group can be open to many interpretations. Specifically, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return. Investors may have benefitted, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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.