Could The Market Be Wrong About Macfarlane Group PLC (LON:MACF) Given Its Attractive Financial Prospects?

Macfarlane Group (LON:MACF) has had a rough three months with its share price down 6.0%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Macfarlane Group's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Macfarlane Group

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 Macfarlane Group is:

13% = UK£9.5m ÷ UK£72m (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.13 in profit.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Macfarlane Group's Earnings Growth And 13% ROE

To start with, Macfarlane Group's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 12%. This probably goes some way in explaining Macfarlane Group's moderate 14% growth over the past five years amongst other factors.

Next, on comparing with the industry net income growth, we found that Macfarlane Group's growth is quite high when compared to the industry average growth of 6.8% in the same period, which is great to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Macfarlane Group is trading on a high P/E or a low P/E, relative to its industry.

Is Macfarlane Group Making Efficient Use Of Its Profits?

Macfarlane Group has a three-year median payout ratio of 41%, which implies that it retains the remaining 59% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Macfarlane Group has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

Overall, we are quite pleased with Macfarlane Group's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings.

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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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