Will Weakness in Kainos Group plc's (LON:KNOS) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at Kainos Group's (LON:KNOS) recent performance, when its stock has declined 15% over the past three months. 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 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.

View our latest analysis for Kainos Group

How Do You 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:

33% = UK£52m ÷ UK£159m (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.33 in profit.

What Has ROE Got To Do With 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.

Kainos Group's Earnings Growth And 33% ROE

To begin with, Kainos Group has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 17% also doesn't go unnoticed by us. This likely paved the way for the modest 16% net income growth seen by Kainos Group over the past five years.

Next, on comparing with the industry net income growth, we found that Kainos Group's growth is quite high when compared to the industry average growth of 0.9% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Efficiently Re-investing Its Profits?

Kainos Group has a significant three-year median payout ratio of 72%, meaning that it is left with only 28% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Additionally, Kainos Group has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. 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 67%. As a result, Kainos Group's ROE is not expected to change by much either, which we inferred from the analyst estimate of 31% for future ROE.

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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.