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It is hard to get excited after looking at Holland Colours' (AMS:HOLCO) recent performance, when its stock has declined 4.6% over the past month. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. In this article, we decided to focus on Holland Colours' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Holland Colours
How Is ROE Calculated?
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 Holland Colours is:
8.4% = €5.2m ÷ €61m (Based on the trailing twelve months to March 2024).
The 'return' is the profit over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.08.
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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Holland Colours' Earnings Growth And 8.4% ROE
When you first look at it, Holland Colours' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.0%. But then again, Holland Colours' five year net income shrunk at a rate of 6.3%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.
So, as a next step, we compared Holland Colours' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.8% over the last few years.
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. 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 Holland Colours is trading on a high P/E or a low P/E, relative to its industry.