Most readers would already be aware that Nine Entertainment Holdings' (ASX:NEC) stock increased significantly by 50% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Nine Entertainment Holdings' ROE in this article.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Nine Entertainment Holdings is:
5.6% = AU$147m ÷ AU$2.6b (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.06 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learnt 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 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.
Nine Entertainment Holdings' Earnings Growth And 5.6% ROE
At first glance, Nine Entertainment Holdings' ROE doesn't look very promising. However, its ROE is similar to the industry average of 5.4%, so we won't completely dismiss the company. Particularly, the exceptional 61% net income growth seen by Nine Entertainment Holdings 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 Nine Entertainment Holdings' growth is quite high when compared to the industry average growth of 36% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. 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. 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 Nine Entertainment Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is Nine Entertainment Holdings Using Its Retained Earnings Effectively?
Nine Entertainment Holdings' three-year median payout ratio is a pretty moderate 43%, meaning the company retains 57% of its income. So it seems that Nine Entertainment Holdings is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Moreover, Nine Entertainment Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 93% over the next three years. Regardless, the future ROE for Nine Entertainment Holdings is speculated to rise to 7.2% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
On the whole, we do feel that Nine Entertainment Holdings has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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. 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. Thank you for reading.