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

Eureka Group Holdings' (ASX:EGH) stock is up by a considerable 24% 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. In this article, we decided to focus on Eureka Group Holdings' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Eureka Group Holdings

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 Eureka Group Holdings is:

9.4% = AU$8.1m ÷ AU$86m (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Eureka Group Holdings' Earnings Growth And 9.4% ROE

On the face of it, Eureka Group Holdings' ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 3.5% doesn't go unnoticed by us. But seeing Eureka Group Holdings' five year net income decline of 2.8% over the past five years, we might rethink that. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the shrinking earnings.

As a next step, we compared Eureka Group Holdings' performance with the industry and discovered the industry has shrunk at a rate of 5.9% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. This does offer shareholders some relief

Earnings growth is a huge factor in stock valuation. 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 Eureka Group Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Eureka Group Holdings Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 37% (that is, a retention ratio of 63%), the fact that Eureka Group Holdings' earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Eureka Group Holdings started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 39% of its profits over the next three years. As a result, Eureka Group Holdings' ROE is not expected to change by much either, which we inferred from the analyst estimate of 8.1% for future ROE.

Summary

Overall, we feel that Eureka Group Holdings certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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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