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With its stock down 6.9% over the past month, it is easy to disregard Ermenegildo Zegna (NYSE:ZGN). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Ermenegildo Zegna's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Ermenegildo Zegna
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Ermenegildo Zegna is:
13% = €115m ÷ €914m (Based on the trailing twelve months to June 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 $0.13 in profit.
What Has ROE Got To Do With 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.
Ermenegildo Zegna's Earnings Growth And 13% ROE
To start with, Ermenegildo Zegna's ROE looks acceptable. Even when compared to the industry average of 13% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 46% seen over the past five years by Ermenegildo Zegna. We reckon that there could also be other factors at play here. 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 Ermenegildo Zegna's growth is quite high when compared to the industry average growth of 22% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Ermenegildo Zegna is trading on a high P/E or a low P/E, relative to its industry.