Has Eureka Group Holdings Limited's (ASX:EGH) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Eureka Group Holdings (ASX:EGH) has had a great run on the share market with its stock up by a significant 18% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Eureka Group Holdings' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Eureka Group Holdings

How To Calculate Return On Equity?

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 Eureka Group Holdings is:

11% = AU$9.2m ÷ AU$84m (Based on the trailing twelve months to December 2019).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Eureka Group Holdings' Earnings Growth And 11% ROE

To begin with, Eureka Group Holdings seems to have a respectable ROE. On comparing with the average industry ROE of 6.2% the company's ROE looks pretty remarkable. However, we are curious as to how the high returns still resulted in flat growth for Eureka Group Holdings in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.

Next, we compared Eureka Group Holdings' performance against the industry and found that the industry shrunk its earnings at 1.4% in the same period, which suggests that the company's earnings have been shrinking at a slower rate than its industry, While this is not particularly good, its not particularly bad either.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Eureka Group Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Eureka Group Holdings Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 37% (meaning the company retains63% of profits) in the last three-year period, Eureka Group Holdings' earnings growth was more or les flat. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Only recently, Eureka Group Holdings started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth. 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 39%. However, Eureka Group Holdings' future ROE is expected to decline to 8.4% despite there being not much change anticipated in the company's payout ratio.

Conclusion

Overall, we feel that Eureka Group Holdings certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

If you decide to trade Eureka Group Holdings, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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