Are Strong Financial Prospects The Force That Is Driving The Momentum In Proact IT Group AB (publ)'s STO:PACT) Stock?

Most readers would already be aware that Proact IT Group's (STO:PACT) stock increased significantly by 25% 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. Particularly, we will be paying attention to Proact IT Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Proact IT Group

How Do You 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 Proact IT Group is:

19% = kr114m ÷ kr605m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every SEK1 worth of shareholders' equity, the company generated SEK0.19 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Proact IT Group's Earnings Growth And 19% ROE

To begin with, Proact IT Group seems to have a respectable ROE. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. This certainly adds some context to Proact IT Group's decent 5.3% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Proact IT Group's reported growth was lower than the industry growth of 11% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Proact IT Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Proact IT Group Using Its Retained Earnings Effectively?

Proact IT Group has a three-year median payout ratio of 29%, which implies that it retains the remaining 71% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Proact IT Group is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 25% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 21%.

Conclusion

In total, we are pretty happy with Proact IT Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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