Karooooo's (NASDAQ:KARO) stock up by 7.6% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Karooooo's ROE.
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 Is ROE Calculated?
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 Karooooo is:
25% = R614m ÷ R2.4b (Based on the trailing twelve months to May 2023).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.25 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Karooooo's Earnings Growth And 25% ROE
To begin with, Karooooo has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. So, the substantial 25% net income growth seen by Karooooo over the past five years isn't overly surprising.
Next, on comparing with the industry net income growth, we found that Karooooo's growth is quite high when compared to the industry average growth of 20% in the same period, which is great to see.
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. Has the market priced in the future outlook for KARO? You can find out in our latest intrinsic value infographic research report.
Is Karooooo Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 55% (implying that it keeps only 45% of profits) for Karooooo suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
While Karooooo has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 21% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
In total, we are pretty happy with Karooooo's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.