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Are Strong Financial Prospects The Force That Is Driving The Momentum In Volex plc's LON:VLX) Stock?

Volex's (LON:VLX) stock is up by a considerable 22% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Volex's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Volex

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

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So, based on the above formula, the ROE for Volex is:

21% = US$39m ÷ US$184m (Based on the trailing twelve months to April 2021).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.21 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Volex's Earnings Growth And 21% ROE

To begin with, Volex has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. Under the circumstances, Volex's considerable five year net income growth of 69% was to be expected.

As a next step, we compared Volex'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 5.5%.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Volex is trading on a high P/E or a low P/E, relative to its industry.

Is Volex Efficiently Re-investing Its Profits?

Volex's ' three-year median payout ratio is on the lower side at 23% implying that it is retaining a higher percentage (77%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Besides, Volex has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 17% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

On the whole, we feel that Volex's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.