Is Weakness In Profoto Holding AB (publ) (STO:PRFO) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Profoto Holding (STO:PRFO) has had a rough three months with its share price down 20%. 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. Specifically, we decided to study Profoto Holding's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Profoto Holding

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 Profoto Holding is:

39% = kr118m ÷ kr300m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every SEK1 worth of shareholders' equity, the company generated SEK0.39 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. 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 Profoto Holding's Earnings Growth And 39% ROE

Firstly, we acknowledge that Profoto Holding has a significantly high ROE. Secondly, even when compared to the industry average of 4.5% the company's ROE is quite impressive. This likely paved the way for the modest 16% net income growth seen by Profoto Holding over the past five years.

Next, on comparing Profoto Holding's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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 Profoto Holding is trading on a high P/E or a low P/E, relative to its industry.

Is Profoto Holding Making Efficient Use Of Its Profits?

Profoto Holding has a significant three-year median payout ratio of 84%, meaning that it is left with only 16% 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.

Besides, Profoto Holding has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

In total, we are pretty happy with Profoto Holding's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.