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It is hard to get excited after looking at Shopify's (NYSE:SHOP) recent performance, when its stock has declined 46% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Shopify's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 Shopify
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Shopify is:
1.9% = US$182m ÷ US$9.8b (Based on the trailing twelve months to March 2022).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.02.
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 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.
A Side By Side comparison of Shopify's Earnings Growth And 1.9% ROE
It is hard to argue that Shopify's ROE is much good in and of itself. Even when compared to the industry average of 17%, the ROE figure is pretty disappointing. In spite of this, Shopify was able to grow its net income considerably, at a rate of 78% in the last five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Shopify's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 15% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is SHOP fairly valued? This infographic on the company's intrinsic value has everything you need to know.