Piovan (BIT:PVN) has had a great run on the share market with its stock up by a significant 22% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Piovan's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Piovan is:
24% = €18m ÷ €73m (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 €0.24 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 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.
A Side By Side comparison of Piovan's Earnings Growth And 24% ROE
Firstly, we acknowledge that Piovan has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 6.2% also doesn't go unnoticed by us. Despite this, Piovan's five year net income growth was quite low averaging at only 3.9%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that Piovan's growth is quite high when compared to the industry average growth of 3.0% 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. This then helps them determine if the stock is placed for a bright or bleak future. Is Piovan fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Piovan Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 42% (implying that the company retains the remaining 58% of its income), Piovan's earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Piovan started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 52% over the next three years.
Overall, we are quite pleased with Piovan's performance. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 3 risks we have identified for Piovan visit our risks dashboard for free.
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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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