Are Robust Financials Driving The Recent Rally In WiseTech Global Limited's (ASX:WTC) Stock?

WiseTech Global (ASX:WTC) has had a great run on the share market with its stock up by a significant 37% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study WiseTech Global's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for WiseTech Global

How To Calculate Return On Equity?

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 WiseTech Global is:

11% = AU$91m ÷ AU$830m (Based on the trailing twelve months to December 2019).

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?

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.

WiseTech Global's Earnings Growth And 11% ROE

To begin with, WiseTech Global seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 14% does temper our expectations. However, we are pleased to see the impressive 50% net income growth reported by WiseTech Global over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this also does lend some color to the high earnings growth seen by the company.

As a next step, we compared WiseTech Global'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 14%.

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). 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 WiseTech Global is trading on a high P/E or a low P/E, relative to its industry.

Is WiseTech Global Making Efficient Use Of Its Profits?

WiseTech Global has a really low three-year median payout ratio of 20%, meaning that it has the remaining 80% left over to reinvest into its business. So it looks like WiseTech Global is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, WiseTech Global has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 20%. However, WiseTech Global's ROE is predicted to rise to 15% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we are quite pleased with WiseTech Global's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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. 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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