With its stock down 8.1% over the past month, it is easy to disregard Videndum (LON:VID). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Videndum's ROE.
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 ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Videndum is:
15% = UK£26m ÷ UK£174m (Based on the trailing twelve months to December 2021).
The 'return' refers to a company's earnings over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.15.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of Videndum's Earnings Growth And 15% ROE
To begin with, Videndum seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 12%. As you might expect, the 15% net income decline reported by Videndum is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 5.5% in the same period, we still found Videndum's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is VID fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Videndum Using Its Retained Earnings Effectively?
Looking at its three-year median payout ratio of 46% (or a retention ratio of 54%) which is pretty normal, Videndum's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
In addition, Videndum has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 41%. Regardless, the future ROE for Videndum is predicted to rise to 21% despite there being not much change expected in its payout ratio.
Overall, we feel that Videndum certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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