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It is hard to get excited after looking at Mercury NZ's (NZSE:MCY) recent performance, when its stock has declined 3.4% over the past week. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Mercury NZ's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for Mercury NZ
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 Mercury NZ is:
0.8% = NZ$38m ÷ NZ$4.8b (Based on the trailing twelve months to December 2023).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.01 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Mercury NZ's Earnings Growth And 0.8% ROE
It is hard to argue that Mercury NZ's ROE is much good in and of itself. Even when compared to the industry average of 8.7%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 8.5% seen by Mercury NZ over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
That being said, we compared Mercury NZ's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 0.8% in the same 5-year period.
Earnings growth is an important metric to consider when valuing a stock. 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 Mercury NZ is trading on a high P/E or a low P/E, relative to its industry.