Could The Market Be Wrong About Pearson plc (LON:PSON) Given Its Attractive Financial Prospects?

With its stock down 8.5% over the past three months, it is easy to disregard Pearson (LON:PSON). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Pearson's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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How Is ROE Calculated?

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 Pearson is:

12% = UK£443m ÷ UK£3.6b (Based on the trailing twelve months to June 2025).

The 'return' is the profit over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.12.

See our latest analysis for Pearson

What Has ROE Got To Do With 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.

Pearson's Earnings Growth And 12% ROE

To begin with, Pearson seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.8%. This probably laid the ground for Pearson's moderate 11% net income growth seen over the past five years.

Next, on comparing Pearson's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 9.2% over the last few years.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is PSON worth today? The intrinsic value infographic in our free research report helps visualize whether PSON is currently mispriced by the market.

Is Pearson Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 46% (implying that the company retains 54% of its profits), it seems that Pearson is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Pearson is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. 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 39%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 11%.

Summary

In total, we are pretty happy with Pearson's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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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.