Are Strong Financial Prospects The Force That Is Driving The Momentum In Metcash Limited’s ASX:MTS) Stock?

Metcash (ASX:MTS) has had a great run on the share market with its stock up by a significant 12% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Metcash’s ROE in this article.

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.

See our latest analysis for Metcash

How Is ROE Calculated?

Return on equity 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 Metcash is:

24% = AU$275m ÷ AU$1.1b (Based on the trailing twelve months to October 2023).

The ‘return’ is the yearly profit. That means that for every A$1 worth of shareholders’ equity, the company generated A$0.24 in profit.

Why Is ROE Important For Earnings Growth?

So far, we’ve learned that ROE is a measure of a company’s profitability. 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.

A Side By Side comparison of Metcash’s Earnings Growth And 24% ROE

First thing first, we like that Metcash has an impressive ROE. Secondly, even when compared to the industry average of 14% the company’s ROE is quite impressive. Under the circumstances, Metcash’s considerable five year net income growth of 37% was to be expected.

As a next step, we compared Metcash’s net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 18%.

Story continues

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock’s future looks promising or ominous. What is MTS worth today? The intrinsic value infographic in our free research report helps visualize whether MTS is currently mispriced by the market.

Is Metcash Using Its Retained Earnings Effectively?

Metcash’s significant three-year median payout ratio of 83% (where it is retaining only 17% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Besides, Metcash has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its 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 70%. Accordingly, forecasts suggest that Metcash’s future ROE will be 22% which is again, similar to the current ROE.

Summary

In total, we are pretty happy with Metcash’s performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that’s probably a good sign. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.