Auto Trader Group plc (LON:AUTO) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

With its stock down 6.2% over the past month, it is easy to disregard Auto Trader Group (LON:AUTO). 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. In this article, we decided to focus on Auto Trader 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Auto Trader Group

How To Calculate Return On Equity?

The formula for ROE is:

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

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

41% = UK£156m ÷ UK£381m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.41 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 Auto Trader Group's Earnings Growth And 41% ROE

Firstly, we acknowledge that Auto Trader Group has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. This likely paved the way for the modest 12% net income growth seen by Auto Trader Group over the past five years. growth

We then performed a comparison between Auto Trader Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 11% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Auto Trader Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Auto Trader Group Efficiently Re-investing Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.

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 33%. Regardless, the future ROE for Auto Trader Group is predicted to rise to 55% despite there being not much change expected in its payout ratio.

Summary

On the whole, we feel that Auto Trader Group's performance has been quite good. 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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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