Will Weakness in PWR Holdings Limited's (ASX:PWH) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at PWR Holdings' (ASX:PWH) recent performance, when its stock has declined 3.6% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to PWR Holdings' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for PWR Holdings

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 PWR Holdings is:

24% = AU$13m ÷ AU$54m (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.24 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

PWR Holdings' Earnings Growth And 24% ROE

To begin with, PWR Holdings has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. This probably laid the groundwork for PWR Holdings' moderate 14% net income growth seen over the past five years.

Next, on comparing PWR Holdings' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 13% in the same period.

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. 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 PWR Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is PWR Holdings Efficiently Re-investing Its Profits?

PWR Holdings has a significant three-year median payout ratio of 61%, meaning that it is left with only 39% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Besides, PWR Holdings has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its 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 54%. Accordingly, forecasts suggest that PWR Holdings' future ROE will be 29% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with PWR Holdings' performance. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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