Plexure Group (NZSE:PLX) has had a great run on the share market with its stock up by a significant 37% over the last month. 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. In this article, we decided to focus on Plexure Group's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To 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 Plexure Group is:
6.7% = NZ$1.0m ÷ NZ$15m (Based on the trailing twelve months to March 2020).
The 'return' is the yearly profit. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.07.
Why Is ROE Important For Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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 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.
A Side By Side comparison of Plexure Group's Earnings Growth And 6.7% ROE
At first glance, Plexure Group's ROE doesn't look very promising. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Plexure Group grew its net income at a significant rate of 46% in the last five years. We reckon that there could be other factors at play here. 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.
When you consider the fact that the industry earnings have shrunk at a rate of 24% in the same period, the company's net income growth is pretty remarkable.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Plexure Group is trading on a high P/E or a low P/E, relative to its industry.
Is Plexure Group Making Efficient Use Of Its Profits?
Given that Plexure Group doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
In total, it does look like Plexure Group has some positive aspects to its business. 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Plexure Group visit our risks dashboard for free.
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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.