Most readers would already be aware that Michelmersh Brick Holdings' (LON:MBH) stock increased significantly by 31% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Michelmersh Brick Holdings' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You 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 Michelmersh Brick Holdings is:
9.2% = UK£7.2m ÷ UK£78m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.09 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
Michelmersh Brick Holdings' Earnings Growth And 9.2% ROE
To begin with, Michelmersh Brick Holdings seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 9.2%. This probably goes some way in explaining Michelmersh Brick Holdings' significant 21% net income growth over the past five years amongst other factors. We believe that there might also be other aspects that are positively influencing the company's earnings 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 Michelmersh Brick Holdings' reported growth was lower than the industry growth of 28% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. 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 MBH fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Michelmersh Brick Holdings 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.
Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 32% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
In total, it does look like Michelmersh Brick Holdings has some positive aspects to its business. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Michelmersh Brick Holdings and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.
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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