REA Group's (ASX:REA) stock is up by a considerable 9.6% over the past week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on REA Group's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
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 REA Group is:
27% = AU$372m ÷ AU$1.4b (Based on the trailing twelve months to June 2022).
The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.27.
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. 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. 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 REA Group's Earnings Growth And 27% ROE
First thing first, we like that REA Group has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 16% also doesn't go unnoticed by us. As a result, REA Group's exceptional 30% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing with the industry net income growth, we found that REA Group's growth is quite high when compared to the industry average growth of 0.1% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. 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 REA Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is REA Group Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 70% (implying that it keeps only 30% of profits) for REA Group suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Additionally, REA Group has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 55% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
On the whole, we feel that REA Group's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
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