Metcash Limited's (ASX:MTS) Stock Has Fared Decently: Is the Market Following Strong Financials?

Metcash's (ASX:MTS) stock up by 4.9% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Metcash's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Metcash

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 Metcash is:

22% = AU$244m ÷ AU$1.1b (Based on the trailing twelve months to October 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.22 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Metcash's Earnings Growth And 22% ROE

To begin with, Metcash has a pretty high ROE which is interesting. Even when compared to the industry average of 26% the company's ROE is pretty decent. Therefore, it might not be wrong to say that the impressive five year 43% net income growth seen by Metcash was probably achieved as a result of the high ROE.

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 11% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for MTS? You can find out in our latest intrinsic value infographic research report.

Is Metcash Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 79% (implying that it keeps only 21% 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 70% of its profits over the next three years. Accordingly, forecasts suggest that Metcash's future ROE will be 24% which is again, similar to the current ROE.

Summary

On the whole, we feel that Metcash's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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. 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.