Volt Power Group Limited's (ASX:VPR) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

By
Simply Wall St
Published
September 01, 2021
ASX:VPR
Source: Shutterstock

Volt Power Group (ASX:VPR) has had a great run on the share market with its stock up by a significant 50% over the last week. 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 Volt Power Group'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 Volt Power Group

How To 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 Volt Power Group is:

26% = AU$986k ÷ AU$3.8m (Based on the trailing twelve months to June 2021).

The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.26.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Volt Power Group's Earnings Growth And 26% ROE

To begin with, Volt Power Group has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 4.8% the company's ROE is quite impressive. For this reason, Volt Power Group's five year net income decline of 3.9% raises the question as to why the high ROE didn't translate into earnings growth. So, 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.

However, when we compared Volt Power Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 26% in the same period. This is quite worrisome.

past-earnings-growth
ASX:VPR Past Earnings Growth September 2nd 2021

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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Volt Power Group is trading on a high P/E or a low P/E, relative to its industry.

Is Volt Power Group Using Its Retained Earnings Effectively?

Conclusion

In total, it does look like Volt Power Group has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 4 risks we have identified for Volt Power Group.

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