Korn Ferry (NYSE:KFY) has had a rough three months with its share price down 39%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Korn Ferry'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To 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 Korn Ferry is:
12% = US$158m ÷ US$1.3b (Based on the trailing twelve months to January 2020).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.12.
Why Is ROE Important For Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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. 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.
Korn Ferry's Earnings Growth And 12% ROE
To start with, Korn Ferry's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 12%. This certainly adds some context to Korn Ferry's moderate 20% net income growth seen over the past five years.
As a next step, we compared Korn Ferry'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 14%.
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. Is Korn Ferry fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Korn Ferry Efficiently Re-investing Its Profits?
Korn Ferry's three-year median payout ratio to shareholders is 21% (implying that it retains 79% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Moreover, Korn Ferry is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 17% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
On the whole, we feel that Korn Ferry's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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