Is Weakness In Eureka Group Holdings Limited (ASX:EGH) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Simply Wall St

Sun, Aug 27, 2023, 9:46 PM 4 min read

It is hard to get excited after looking at Eureka Group Holdings' (ASX:EGH) recent performance, when its stock has declined 4.3% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Eureka Group Holdings' ROE.

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.

See our latest analysis for Eureka Group Holdings

How Do You 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 Eureka Group Holdings is:

8.9% = AU$12m ÷ AU$134m (Based on the trailing twelve months to December 2022).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Eureka Group Holdings' Earnings Growth And 8.9% ROE

At first glance, Eureka Group Holdings' ROE doesn't look very promising. However, the fact that the company's ROE is higher than the average industry ROE of 6.8%, is definitely interesting. Even more so after seeing Eureka Group Holdings' exceptional 30% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Therefore, the growth in earnings could also be the result of other factors. Such as- high earnings retention or the company belonging to a high growth industry.

We then compared Eureka Group Holdings' 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 13% in the same 5-year period.

past-earnings-growth — ASX:EGH Past Earnings Growth August 28th 2023

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 Eureka Group Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Eureka Group Holdings Efficiently Re-investing Its Profits?

Eureka Group Holdings has a three-year median payout ratio of 39% (where it is retaining 61% of its income) which is not too low or not too high. So it seems that Eureka Group Holdings is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Eureka Group Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 48% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 5.5%) over the same period.

Conclusion

In total, we are pretty happy with Eureka Group Holdings' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.