MGP Ingredients, Inc.'s (NASDAQ:MGPI) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at MGP Ingredients' (NASDAQ:MGPI) recent performance, when its stock has declined 48% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study MGP Ingredients' 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.

See our latest analysis for MGP Ingredients

How Do You 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 MGP Ingredients is:

12% = US$108m ÷ US$913m (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.12 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. 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.

MGP Ingredients' Earnings Growth And 12% ROE

To start with, MGP Ingredients' ROE looks acceptable. Yet, the fact that the company's ROE is lower than the industry average of 16% does temper our expectations. Still, we can see that MGP Ingredients has seen a remarkable net income growth of 22% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this also does lend some color to the high earnings growth seen by the company.

As a next step, we compared MGP Ingredients' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

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. If you're wondering about MGP Ingredients''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is MGP Ingredients Using Its Retained Earnings Effectively?

MGP Ingredients' three-year median payout ratio to shareholders is 10.0%, which is quite low. This implies that the company is retaining 90% of its profits. So it looks like MGP Ingredients is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, MGP Ingredients 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 10% of its profits over the next three years.

Conclusion

In total, we are pretty happy with MGP Ingredients' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.