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PagSeguro Digital (NYSE:PAGS) has had a rough three months with its share price down 5.1%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study PagSeguro Digital's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 PagSeguro Digital is:
16% = R$1.4b ÷ R$8.7b (Based on the trailing twelve months to June 2020).
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 $0.16 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
A Side By Side comparison of PagSeguro Digital's Earnings Growth And 16% ROE
To begin with, PagSeguro Digital seems to have a respectable ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. This certainly adds some context to PagSeguro Digital's exceptional 50% net income growth seen over the past five years. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared PagSeguro Digital's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 11% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if PagSeguro Digital is trading on a high P/E or a low P/E, relative to its industry.
Is PagSeguro Digital Efficiently Re-investing Its Profits?
While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.
Our latest analyst data shows that the future payout ratio of the company is expected to drop to 15% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 19%, over the same period.
Overall, we are quite pleased with PagSeguro Digital's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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.
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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