Mr Price Group Limited's (JSE:MRP) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Mr Price Group's (JSE:MRP) stock is up by a considerable 21% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Mr Price Group's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Mr Price Group

How To 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 Mr Price Group is:

22% = R3.4b ÷ R15b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.22 in profit.

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. 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.

A Side By Side comparison of Mr Price Group's Earnings Growth And 22% ROE

To start with, Mr Price Group's ROE looks acceptable. On comparing with the average industry ROE of 13% the company's ROE looks pretty remarkable. However, for some reason, the higher returns aren't reflected in Mr Price Group's meagre five year net income growth average of 4.0%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Mr Price Group's reported growth was lower than the industry growth of 11% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Mr Price Group is trading on a high P/E or a low P/E, relative to its industry.

Is Mr Price Group Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 63% (or a retention ratio of 37%), most of Mr Price Group's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, Mr Price Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. 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 65%. As a result, Mr Price Group's ROE is not expected to change by much either, which we inferred from the analyst estimate of 24% for future ROE.

Conclusion

On the whole, we do feel that Mr Price Group has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.