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Eureka Group Holdings' (ASX:EGH) stock is up by a considerable 19% 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. Specifically, we decided to study Eureka Group Holdings' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Eureka Group Holdings
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 Eureka Group Holdings is:
9.4% = AU$8.1m ÷ AU$86m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.09 in profit.
Why Is ROE Important For 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.
Eureka Group Holdings' Earnings Growth And 9.4% ROE
On the face of it, Eureka Group Holdings' ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 3.6% doesn't go unnoticed by us. However, Eureka Group Holdings' five year net income decline rate was 2.8%. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. So that could be one of the factors that are causing earnings growth to shrink.
We then compared Eureka Group Holdings' performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 5.9% in the same period. While this is not particularly good, its not particularly bad either.
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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Eureka Group Holdings is trading on a high P/E or a low P/E, relative to its industry.