Are Robust Financials Driving The Recent Rally In Karooooo Ltd.'s (NASDAQ:KARO) Stock?

Karooooo (NASDAQ:KARO) has had a great run on the share market with its stock up by a significant 12% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Karooooo'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Karooooo

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 Karooooo is:

30% = R896m ÷ R3.0b (Based on the trailing twelve months to November 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.30 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. 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.

Karooooo's Earnings Growth And 30% ROE

First thing first, we like that Karooooo has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. So, the substantial 24% net income growth seen by Karooooo over the past five years isn't overly surprising.

As a next step, we compared Karooooo's 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 20%.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Karooooo's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Karooooo Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 69% (implying that it keeps only 31% of profits) for Karooooo suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Additionally, Karooooo has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 68%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 29%.

Summary

On the whole, we feel that Karooooo's performance has been quite good. 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 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. 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.