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Nine Entertainment Holdings' (ASX:NEC) stock is up by 7.1% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study Nine Entertainment 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Nine Entertainment Holdings is:
11% = AU$217m ÷ AU$2.1b (Based on the trailing twelve months to December 2021).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.11 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Nine Entertainment Holdings' Earnings Growth And 11% ROE
To start with, Nine Entertainment Holdings' ROE looks acceptable. On comparing with the average industry ROE of 6.7% the company's ROE looks pretty remarkable. As you might expect, the 5.3% net income decline reported by Nine Entertainment Holdings is a bit of a surprise. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
That being said, we compared Nine Entertainment Holdings' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 0.5% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Nine Entertainment Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is Nine Entertainment Holdings Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 79% (implying that 21% of the profits are retained), most of Nine Entertainment Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 2 risks we have identified for Nine Entertainment Holdings by visiting our risks dashboard for free on our platform here.
Additionally, Nine Entertainment Holdings has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 72%. Regardless, the future ROE for Nine Entertainment Holdings is predicted to rise to 17% despite there being not much change expected in its payout ratio.
On the whole, we do feel that Nine Entertainment Holdings has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.