Declining Stock and Decent Financials: Is The Market Wrong About Eureka Group Holdings Limited (ASX:EGH)?




  • In Business
  • 2022-09-27 22:55:46Z
  • By Simply Wall St.
 

With its stock down 8.2% over the past three months, it is easy to disregard Eureka Group Holdings (ASX:EGH). 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 Eureka Group Holdings' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Eureka Group Holdings

How Is ROE Calculated?

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 Eureka Group Holdings is:

8.3% = AU$8.2m ÷ AU$99m (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.08 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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 Eureka Group Holdings' Earnings Growth And 8.3% ROE

At first glance, Eureka Group Holdings' ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.3%. Particularly, the exceptional 23% net income growth seen by Eureka Group Holdings over the past five years is pretty remarkable. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Eureka Group Holdings' growth is quite high when compared to the industry average growth of 0.7% in the same period, which is great to see.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Eureka Group Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Eureka Group Holdings Making Efficient Use Of Its Profits?

The three-year median payout ratio for Eureka Group Holdings is 39%, which is moderately low. The company is retaining the remaining 61%. By the looks of it, the dividend is well covered and Eureka Group Holdings is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Eureka Group Holdings has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 36%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 7.7%.

Summary

Overall, we feel that Eureka Group Holdings certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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