It is hard to get excited after looking at Zumiez's (NASDAQ:ZUMZ) recent performance, when its stock has declined 25% 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. Particularly, we will be paying attention to Zumiez's ROE today.
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.
How To Calculate Return On Equity?
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 Zumiez is:
25% = US$119m ÷ US$468m (Based on the trailing twelve months to January 2022).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.25.
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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Zumiez's Earnings Growth And 25% ROE
First thing first, we like that Zumiez has an impressive ROE. On the other hand, the industry average is quite high at 33%, which tempers our excitement. That being the case, the significant five-year 35% net income growth reported by Zumiez comes as a pleasant surprise. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently. Bear in mind, the company does have a high ROE. It is just that the industry ROE is higher. So the high ROE levels also provide some context to the high earnings growth seen by the company.
We then compared Zumiez's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 25% in the same period.
Earnings growth is a huge factor in stock valuation. 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. Is Zumiez fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Zumiez Using Its Retained Earnings Effectively?
Zumiez doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.
On the whole, we feel that Zumiez's performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.
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.