Mercury NZ (NZSE:MCY) has had a great run on the share market with its stock up by a significant 13% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Mercury NZ's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Mercury NZ is:
9.6% = NZ$336m ÷ NZ$3.5b (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.10 in profit.
What Has ROE Got To Do With 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 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.
Mercury NZ's Earnings Growth And 9.6% ROE
At first glance, Mercury NZ's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 8.9%, we may spare it some thought. Particularly, the exceptional 27% net income growth seen by Mercury NZ over the past five years is pretty remarkable. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Mercury NZ's growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Mercury NZ fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Mercury NZ Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 94% (implying that it keeps only 5.9% of profits) for Mercury NZ suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Additionally, Mercury NZ has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 109% of its profits over the next three years. Regardless, Mercury NZ's ROE is speculated to decline to 5.5% despite there being no anticipated change in its payout ratio.
In total, we're a bit ambivalent about Mercury NZ's performance. While no doubt its earnings growth is pretty substantial, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, especially during troubled times. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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