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

Metcash (ASX:MTS) has had a rough three months with its share price down 20%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Metcash's ROE in this article.

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.

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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$283m ÷ AU$1.6b (Based on the trailing twelve months to April 2025).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.17.

View our latest analysis for Metcash

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Metcash's Earnings Growth And 17% ROE

To begin with, Metcash seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 17%. Consequently, this likely laid the ground for the decent growth of 13% seen over the past five years by Metcash.

Next, on comparing with the industry net income growth, we found that Metcash's growth is quite high when compared to the industry average growth of 2.0% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Metcash fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Metcash Using Its Retained Earnings Effectively?

Metcash has a significant three-year median payout ratio of 78%, meaning that it is left with only 22% 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.

Moreover, Metcash is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 71%. Accordingly, forecasts suggest that Metcash's future ROE will be 18% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that Metcash's performance has been quite good. 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.