Is Weakness In Metcash Limited (ASX:MTS) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 13% over the past three months, it is easy to disregard Metcash (ASX:MTS). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Metcash's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Metcash

How Do You Calculate Return On Equity?

The formula for ROE is:

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

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

17% = AU$258m ÷ AU$1.5b (Based on the trailing twelve months to April 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.17.

Why Is ROE Important For 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. 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.

Metcash's Earnings Growth And 17% ROE

To start with, Metcash's ROE looks acceptable. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. This certainly adds some context to Metcash's exceptional 26% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Metcash's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 25% in the same period.

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. If you're wondering about Metcash's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Metcash Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 83% (implying that it keeps only 17% of profits) for Metcash suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Moreover, Metcash is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. 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 70%. Accordingly, forecasts suggest that Metcash's future ROE will be 18% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with Metcash's 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.