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Are Strong Financial Prospects The Force That Is Driving The Momentum In Vortiv Limited's ASX:VOR) Stock?

Simply Wall St
·4 min read

Vortiv's's (ASX:VOR) stock is up by a considerable 70% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Vortiv's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Vortiv

How Is ROE Calculated?

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 Vortiv is:

13% = AU$3.0m ÷ AU$22m (Based on the trailing twelve months to March 2020).

The 'return' refers to a company's earnings over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.13 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Vortiv's Earnings Growth And 13% ROE

At first glance, Vortiv seems to have a decent ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. This probably laid the ground for Vortiv's significant 60% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Vortiv'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 41%.

ASX:VOR Past Earnings Growth May 29th 2020
ASX:VOR Past Earnings Growth May 29th 2020

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Vortiv is trading on a high P/E or a low P/E, relative to its industry.

Is Vortiv Making Efficient Use Of Its Profits?

Vortiv doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Summary

On the whole, we feel that Vortiv's performance has been quite good. 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 4 risks we have identified for Vortiv.

Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.

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.