Group's (ASX:PTB) stock is up by 8.6% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study Group's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Group

How Do You Calculate Return On Equity?

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 Group is:

11% = AU$9.8m ÷ AU$88m (Based on the trailing twelve months to December 2020).

The 'return' is the profit 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$0.11 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Group's Earnings Growth And 11% ROE

To begin with, Group seems to have a respectable ROE. Especially when compared to the industry average of 8.8% the company's ROE looks pretty impressive. Probably as a result of this, Group was able to see an impressive net income growth of 20% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 38% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Group Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 97% (implying that it keeps only 2.8% of profits) for Group suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Besides, Group has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 40% over the next three years. Still forecasts suggest that Group's future ROE will drop to 8.1% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.

Conclusion

In total, it does look like Group has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, probably due to its high returns. However, it does reinvest little to almost none of its profits, so we wonder what effect this could have on its future growth prospects. 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.

This article by Simply Wall St is general in nature. 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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