rhipe (ASX:RHP) has had a great run on the share market with its stock up by a significant 42% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to rhipe's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. 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 rhipe is:
12% = AU$6.4m ÷ AU$56m (Based on the trailing twelve months to December 2019).
The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.12.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
rhipe's Earnings Growth And 12% ROE
At first glance, rhipe seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. Consequently, this likely laid the ground for the impressive net income growth of 63% seen over the past five years by rhipe. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared rhipe's 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 48%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 rhipe is trading on a high P/E or a low P/E, relative to its industry.
Is rhipe Efficiently Re-investing Its Profits?
rhipe has a significant three-year median payout ratio of 54%, meaning the company only retains 46% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 56% of its profits over the next three years. Accordingly, forecasts suggest that rhipe's future ROE will be 13% which is again, similar to the current ROE.
Overall, we are quite pleased with rhipe's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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.
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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