Auto Trader Group plc's (LON:AUTO) Stock Been Rising: Are Strong Financials Guiding The Market?

Auto Trader Group's (LON:AUTO) stock up by 6.8% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Auto Trader Group

How Do You 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:

47% = UK£257m ÷ UK£552m (Based on the trailing twelve months to March 2024).

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 £0.47 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 47% 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 32% which is quite remarkable. This probably laid the groundwork for Auto Trader Group's moderate 6.9% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Auto Trader Group's reported growth was lower than the industry growth of 18% over the last few years, which is not something we like to see.

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. Is AUTO fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Auto Trader Group Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 34% (implying that the company retains 66% of its profits), it seems that Auto Trader Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Auto Trader Group is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 32%. Accordingly, forecasts suggest that Auto Trader Group's future ROE will be 53% which is again, similar to the current ROE.

Conclusion

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 a good amount of growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.