Ultra Electronics Holdings (LON:ULE) has had a rough three months with its share price down 2.6%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Ultra Electronics Holdings' ROE today.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Ultra Electronics Holdings is:
18% = UK£84m ÷ UK£465m (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.18.
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. 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 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.
Ultra Electronics Holdings' Earnings Growth And 18% ROE
To begin with, Ultra Electronics Holdings seems to have a respectable ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. This certainly adds some context to Ultra Electronics Holdings' decent 13% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that Ultra Electronics Holdings' growth is quite high when compared to the industry average growth of 9.7% in the same period, which is great to see.
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. What is ULE worth today? The intrinsic value infographic in our free research report helps visualize whether ULE is currently mispriced by the market.
Is Ultra Electronics Holdings Making Efficient Use Of Its Profits?
While Ultra Electronics Holdings has a three-year median payout ratio of 76% (which means it retains 24% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Besides, Ultra Electronics Holdings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 44% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
In total, we are pretty happy with Ultra Electronics Holdings' performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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