Yahoo Finance Eureka Group Holdings Limited's (ASX:EGH) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
Eureka Group Holdings (ASX:EGH) has had a great run on the share market with its stock up by a significant 36% over the last three months. 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. Specifically, we decided to study Eureka Group Holdings' 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.
See our latest analysis for Eureka Group Holdings
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 Eureka Group Holdings is:
6.8% = AU$5.9m ÷ AU$88m (Based on the trailing twelve months to December 2020).
The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.07 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Eureka Group Holdings' Earnings Growth And 6.8% ROE
When you first look at it, Eureka Group Holdings' ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 3.7% doesn't go unnoticed by us. But seeing Eureka Group Holdings' five year net income decline of 6.1% over the past five years, we might rethink that. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Hence, this goes some way in explaining the shrinking earnings.
As a next step, we compared Eureka Group Holdings' performance with the industry and discovered the industry has shrunk at a rate of 9.2% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. This does offer shareholders some relief
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). 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 Eureka Group Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is Eureka Group Holdings Using Its Retained Earnings Effectively?
In spite of a normal three-year median payout ratio of 37% (that is, a retention ratio of 63%), the fact that Eureka Group Holdings' earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, Eureka Group Holdings only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 44% of its profits over the next three years. Accordingly, forecasts suggest that Eureka Group Holdings' future ROE will be 7.2% which is again, similar to the current ROE.
Conclusion
In total, it does look like Eureka Group Holdings has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. 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 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
