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It is hard to get excited after looking at ZOO Digital Group's (LON:ZOO) recent performance, when its stock has declined 53% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to ZOO Digital Group's ROE today.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for ZOO Digital Group
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 ZOO Digital Group is:
23% = US$8.2m ÷ US$35m (Based on the trailing twelve months to March 2023).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.23 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. 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.
ZOO Digital Group's Earnings Growth And 23% ROE
Firstly, we acknowledge that ZOO Digital Group has a significantly high ROE. Secondly, even when compared to the industry average of 8.0% the company's ROE is quite impressive. So, the substantial 53% net income growth seen by ZOO Digital Group over the past five years isn't overly surprising.
As a next step, we compared ZOO Digital Group'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 18%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 ZOO Digital Group is trading on a high P/E or a low P/E, relative to its industry.