Pfeiffer Vacuum Technology (ETR:PFV) has had a rough three months with its share price down 13%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Pfeiffer Vacuum Technology's ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To Calculate Return On Equity?
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 Pfeiffer Vacuum Technology is:
9.7% = €38m ÷ €396m (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.10 in profit.
What Has ROE Got To Do With 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.
Pfeiffer Vacuum Technology's Earnings Growth And 9.7% ROE
At first glance, Pfeiffer Vacuum Technology seems to have a decent ROE. On comparing with the average industry ROE of 5.8% the company's ROE looks pretty remarkable. Yet, Pfeiffer Vacuum Technology has posted measly growth of 2.9% over the past five years. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
We then performed a comparison between Pfeiffer Vacuum Technology's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 3.4% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Pfeiffer Vacuum Technology is trading on a high P/E or a low P/E, relative to its industry.
Is Pfeiffer Vacuum Technology Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 33% (implying that the company retains the remaining 67% of its income), Pfeiffer Vacuum Technology's earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Pfeiffer Vacuum Technology has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 37% of its profits over the next three years. Regardless, the future ROE for Pfeiffer Vacuum Technology is predicted to rise to 13% despite there being not much change expected in its payout ratio.
Overall, we are quite pleased with Pfeiffer Vacuum Technology's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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