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It is hard to get excited after looking at PWR Holdings' (ASX:PWH) recent performance, when its stock has declined 16% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on PWR Holdings' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 PWR Holdings
How To Calculate Return On Equity?
ROE 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 PWR Holdings is:
25% = AU$25m ÷ AU$100m (Based on the trailing twelve months to June 2024).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.25 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 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.
A Side By Side comparison of PWR Holdings' Earnings Growth And 25% ROE
Firstly, we acknowledge that PWR Holdings has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. This probably laid the groundwork for PWR Holdings' moderate 13% net income growth seen over the past five years.
Next, on comparing PWR Holdings' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% over the last few years.
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. Is PWH fairly valued? This infographic on the company's intrinsic value has everything you need to know.