Is Weakness In Ermenegildo Zegna N.V. (NYSE:ZGN) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Ermenegildo Zegna (NYSE:ZGN) has had a rough three months with its share price down 17%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Ermenegildo Zegna's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Ermenegildo Zegna

How Is ROE Calculated?

ROE 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 Ermenegildo Zegna is:

15% = €136m ÷ €901m (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.15 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Ermenegildo Zegna's Earnings Growth And 15% ROE

At first glance, Ermenegildo Zegna seems to have a decent ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. This certainly adds some context to Ermenegildo Zegna's moderate 20% net income growth seen over the past five years.

We then performed a comparison between Ermenegildo Zegna's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 19% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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 Ermenegildo Zegna fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Ermenegildo Zegna Efficiently Re-investing Its Profits?

Ermenegildo Zegna has a low three-year median payout ratio of 24%, meaning that the company retains the remaining 76% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

While Ermenegildo Zegna has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 33% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Summary

On the whole, we feel that Ermenegildo Zegna's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.