Do Its Financials Have Any Role To Play In Driving Mitchell Services Limited's (ASX:MSV) Stock Up Recently?

Mitchell Services' (ASX:MSV) stock is up by a considerable 15% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Mitchell Services' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Mitchell Services

How Do You 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 Mitchell Services is:

18% = AU$12m ÷ AU$65m (Based on the trailing twelve months to December 2023).

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$0.18.

Why Is ROE Important For 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 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.

Mitchell Services' Earnings Growth And 18% ROE

At first glance, Mitchell Services seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 10%. Needless to say, we are quite surprised to see that Mitchell Services' net income shrunk at a rate of 27% over the past five years. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

So, as a next step, we compared Mitchell Services' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 20% over the last few years.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Mitchell Services''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Mitchell Services Using Its Retained Earnings Effectively?

Mitchell Services' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 69% (or a retention ratio of 31%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 4 risks we have identified for Mitchell Services by visiting our risks dashboard for free on our platform here.

In addition, Mitchell Services only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 112% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 11% over the same period.

Conclusion

On the whole, we do feel that Mitchell Services has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest industry analyst forecasts show that analysts are forecasting a slight improvement in the company's future earnings growth. The company's existing shareholders might have some respite after all. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com