RPS Group plc (LON:RPS) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

By
Simply Wall St
Published
September 08, 2021
LSE:RPS
Source: Shutterstock

Most readers would already be aware that RPS Group's (LON:RPS) stock increased significantly by 17% over the past week. 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. Particularly, we will be paying attention to RPS Group's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for RPS Group

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for RPS Group is:

1.6% = UK£5.7m ÷ UK£348m (Based on the trailing twelve months to June 2021).

The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.02 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

RPS Group's Earnings Growth And 1.6% ROE

As you can see, RPS Group's ROE looks pretty weak. Even compared to the average industry ROE of 8.6%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 39% seen by RPS Group was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared RPS Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 4.1% in the same period.

past-earnings-growth
LSE:RPS Past Earnings Growth September 9th 2021

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for RPS? You can find out in our latest intrinsic value infographic research report.

Is RPS Group Making Efficient Use Of Its Profits?

RPS Group's low three-year median payout ratio of 6.0% (or a retention ratio of 94%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Additionally, RPS Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 41% over the next three years. Still, forecasts suggest that RPS Group's future ROE will rise to 6.2% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

On the whole, we feel that the performance shown by RPS Group can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow 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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