Should Weakness in Zoom Video Communications, Inc.'s (NASDAQ:ZM) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Zoom Video Communications (NASDAQ:ZM) has had a rough three months with its share price down 9.1%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Zoom Video Communications' ROE in this article.

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.

View our latest analysis for Zoom Video Communications

How Do You Calculate Return On Equity?

Return on equity 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 Zoom Video Communications is:

7.9% = US$637m ÷ US$8.0b (Based on the trailing twelve months to January 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Zoom Video Communications' Earnings Growth And 7.9% ROE

At first glance, Zoom Video Communications' ROE doesn't look very promising. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Zoom Video Communications grew its net income at a significant rate of 23% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Zoom Video Communications' growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.

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. What is ZM worth today? The intrinsic value infographic in our free research report helps visualize whether ZM is currently mispriced by the market.

Is Zoom Video Communications Using Its Retained Earnings Effectively?

Given that Zoom Video Communications doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

On the whole, we do feel that Zoom Video Communications has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.