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

REA Group's (ASX:REA) stock is up by a considerable 22% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on REA Group'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.

Check out our latest analysis for REA Group

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for REA Group is:

19% = AU$293m ÷ AU$1.6b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.19 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

REA Group's Earnings Growth And 19% ROE

At first glance, REA Group seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 9.2%. This certainly adds some context to REA Group's decent 16% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that REA Group's reported growth was lower than the industry growth of 30% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 REA Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is REA Group Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 59% (or a retention ratio of 41%) for REA Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, REA Group 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 56% of its profits over the next three years. Still, forecasts suggest that REA Group's future ROE will rise to 33% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we feel that REA Group certainly does have some positive factors to consider. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.