Most readers would already be aware that Norcros' (LON:NXR) stock increased significantly by 25% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Norcros' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
ROE 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 Norcros is:
10% = UK£11m ÷ UK£104m (Based on the trailing twelve months to March 2020).
The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.10 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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 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.
Norcros' Earnings Growth And 10% ROE
At first glance, Norcros seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. This certainly adds some context to Norcros' moderate 12% net income growth seen over the past five years.
As a next step, we compared Norcros' 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 9.3%.
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 NXR fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Norcros Using Its Retained Earnings Effectively?
With a three-year median payout ratio of 40% (implying that the company retains 60% of its profits), it seems that Norcros is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 40%.
Overall, we are quite pleased with Norcros' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 3 risks we have identified for Norcros.
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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