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Mercury NZ's (NZSE:MCY) stock up by 5.9% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Particularly, we will be paying attention to Mercury NZ's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for Mercury NZ
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 Mercury NZ is:
6.0% = NZ$290m ÷ NZ$4.8b (Based on the trailing twelve months to June 2024).
The 'return' is the amount earned after tax over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.06 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Mercury NZ's Earnings Growth And 6.0% ROE
At first glance, Mercury NZ's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 9.0% either. Therefore, it might not be wrong to say that the five year net income decline of 11% seen by Mercury NZ was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
However, when we compared Mercury NZ's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.3% in the same period. This is quite worrisome.
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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Mercury NZ's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.