Is Kainos Group plc's (LON:KNOS) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Kainos Group's (LON:KNOS) stock is up by a considerable 10% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Kainos Group's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Kainos Group

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

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

31% = UK£42m ÷ UK£137m (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.31 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. 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.

A Side By Side comparison of Kainos Group's Earnings Growth And 31% ROE

Firstly, we acknowledge that Kainos Group has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 18% also doesn't go unnoticed by us. Under the circumstances, Kainos Group's considerable five year net income growth of 21% was to be expected.

As a next step, we compared Kainos Group's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 18% in the same period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for KNOS? You can find out in our latest intrinsic value infographic research report.

Is Kainos Group Using Its Retained Earnings Effectively?

Kainos Group has a significant three-year median payout ratio of 72%, meaning the company only retains 28% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, Kainos Group is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 56% over the next three years. The fact that the company's ROE is expected to rise to 41% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we feel that Kainos Group's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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. 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.