Mainfreight Limited (NZSE:MFT) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

With its stock down 7.2% over the past month, it is easy to disregard Mainfreight (NZSE:MFT). 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 Mainfreight'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.

Check out our latest analysis for Mainfreight

How To Calculate Return On Equity?

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 Mainfreight is:

25% = NZ$426m ÷ NZ$1.7b (Based on the trailing twelve months to March 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.25 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Mainfreight's Earnings Growth And 25% ROE

To begin with, Mainfreight has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 18% also doesn't go unnoticed by us. Under the circumstances, Mainfreight's considerable five year net income growth of 31% was to be expected.

We then performed a comparison between Mainfreight's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 31% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Mainfreight is trading on a high P/E or a low P/E, relative to its industry.

Is Mainfreight Efficiently Re-investing Its Profits?

Mainfreight's three-year median payout ratio is a pretty moderate 40%, meaning the company retains 60% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Mainfreight is reinvesting its earnings efficiently.

Additionally, Mainfreight has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 49% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 18% over the same period.

Summary

In total, we are pretty happy with Mainfreight's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.