Auto Trader Group (LON:AUTO) has had a rough week with its share price down 9.4%. 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. Particularly, we will be paying attention to Auto Trader Group'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Auto Trader Group is:
41% = UK£156m ÷ UK£381m (Based on the trailing twelve months to September 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 £0.41.
What Is The Relationship Between ROE And 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
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 11% which is quite remarkable. Probably as a result of this, Auto Trader Group was able to see a decent net income growth of 12% over the last five years.
As a next step, we compared Auto Trader Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.1%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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.
Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 33% of its profits over the next three years. Still, forecasts suggest that Auto Trader Group's future ROE will rise to 61% even though the the company's payout ratio is not expected to change by much.
On the whole, we feel that Auto Trader Group's performance has been quite good. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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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