Mayfield Childcare Limited's (ASX:MFD) Stock Is Going Strong: Is the Market Following Fundamentals?

Mayfield Childcare's (ASX:MFD) stock is up by a considerable 24% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Mayfield Childcare's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Mayfield Childcare

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 Mayfield Childcare is:

11% = AU$3.0m ÷ AU$27m (Based on the trailing twelve months to June 2020).

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$0.11.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Mayfield Childcare's Earnings Growth And 11% ROE

To begin with, Mayfield Childcare seems to have a respectable ROE. On comparing with the average industry ROE of 9.1% the company's ROE looks pretty remarkable. This probably laid the ground for Mayfield Childcare's significant 26% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Mayfield Childcare's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 18% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for MFD? You can find out in our latest intrinsic value infographic research report

Is Mayfield Childcare Making Efficient Use Of Its Profits?

Mayfield Childcare has a significant three-year median payout ratio of 69%, meaning the company only retains 31% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, Mayfield Childcare is determined to keep sharing its profits with shareholders which we infer from its long history of three 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 60%. Accordingly, forecasts suggest that Mayfield Childcare's future ROE will be 12% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that Mayfield Childcare'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. 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. 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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