With its stock down 1.3% over the past week, it is easy to disregard Intershop Holding (VTX:ISN). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Intershop Holding's ROE today.
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.
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 Intershop Holding is:
9.7% = CHF63m ÷ CHF653m (Based on the trailing twelve months to June 2020).
The 'return' is the yearly profit. So, this means that for every CHF1 of its shareholder's investments, the company generates a profit of CHF0.10.
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. 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.
A Side By Side comparison of Intershop Holding's Earnings Growth And 9.7% ROE
At first glance, Intershop Holding seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.2%. This certainly adds some context to Intershop Holding's decent 11% net income growth seen over the past five years.
We then compared Intershop Holding's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 20% in the same period, which is a bit concerning.
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. If you're wondering about Intershop Holding's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Intershop Holding Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 66% (or a retention ratio of 34%) for Intershop Holding suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Moreover, Intershop Holding 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 93% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 7.3%) over the same period.
In total, it does look like Intershop Holding has some positive aspects to its business. 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. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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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