Are QinetiQ Group plc's (LON:QQ.) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

QinetiQ Group (LON:QQ.) has had a rough three months with its share price down 11%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on QinetiQ Group's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for QinetiQ Group

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 QinetiQ Group is:

17% = UK£180m ÷ UK£1.0b (Based on the trailing twelve months to September 2022).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.17 in profit.

Why Is ROE Important For 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. 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 QinetiQ Group's Earnings Growth And 17% ROE

To start with, QinetiQ Group's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 13%. As you might expect, the 3.4% net income decline reported by QinetiQ Group is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

That being said, we compared QinetiQ Group's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 6.0% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is QQ. worth today? The intrinsic value infographic in our free research report helps visualize whether QQ. is currently mispriced by the market.

Is QinetiQ Group Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 32% (where it is retaining 68% of its profits), QinetiQ Group has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, QinetiQ Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 30%. Regardless, QinetiQ Group's ROE is speculated to decline to 13% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we do feel that QinetiQ Group has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, we studied current analyst estimates and discovered that analysts expect the company's earnings growth to improve slightly. This could offer some relief to the company's existing shareholders. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.