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Macfarlane Group (LON:MACF) has had a great run on the share market with its stock up by a significant 20% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Macfarlane Group's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Macfarlane Group
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 Macfarlane Group is:
13% = UK£10m ÷ UK£80m (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.13.
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. 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 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.
Macfarlane Group's Earnings Growth And 13% ROE
To start with, Macfarlane Group's ROE looks acceptable. Even when compared to the industry average of 12% the company's ROE looks quite decent. This probably goes some way in explaining Macfarlane Group's moderate 13% growth over the past five years amongst other factors.
Next, on comparing with the industry net income growth, we found that Macfarlane Group's growth is quite high when compared to the industry average growth of 5.7% 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. 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 Macfarlane Group is trading on a high P/E or a low P/E, relative to its industry.