Most readers would already be aware that Masterflex's (ETR:MZX) stock increased significantly by 21% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Masterflex'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
ROE 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 Masterflex is:
2.4% = €1.0m ÷ €43m (Based on the trailing twelve months to March 2021).
The 'return' is the yearly profit. That means that for every €1 worth of shareholders' equity, the company generated €0.02 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Masterflex's Earnings Growth And 2.4% ROE
On the face of it, Masterflex's ROE is not much to talk about. Next, when compared to the average industry ROE of 6.0%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Masterflex's five year net income decline of 13% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
As a next step, we compared Masterflex's performance with the industry and found thatMasterflex's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 1.5% in the same period, which is a slower than the company.
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). Doing so will help them establish if the stock's future looks promising or ominous. What is MZX worth today? The intrinsic value infographic in our free research report helps visualize whether MZX is currently mispriced by the market.
Is Masterflex Efficiently Re-investing Its Profits?
Masterflex's low three-year median payout ratio of 20% (implying that it retains the remaining 80% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Masterflex has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management 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 18% of its profits over the next three years. Still, forecasts suggest that Masterflex's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.
Overall, we have mixed feelings about Masterflex. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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