With its stock down 6.5% over the past month, it is easy to disregard Mader Group (ASX:MAD). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Mader Group's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Mader Group

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 Mader Group is:

34% = AU$18m ÷ AU$54m (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.34.

What Has ROE Got To Do With 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 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 Mader Group's Earnings Growth And 34% ROE

First thing first, we like that Mader Group has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 8.8% also doesn't go unnoticed by us. So, the substantial 30% net income growth seen by Mader Group over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Mader Group's growth is quite high when compared to the industry average growth of 21% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Mader Group is trading on a high P/E or a low P/E, relative to its industry.

Is Mader Group Using Its Retained Earnings Effectively?

Mader Group has a three-year median payout ratio of 31% (where it is retaining 69% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Mader Group is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Along with seeing a growth in earnings, Mader Group only recently started paying dividends. Its quite possible that the company was looking to impress 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 35%. As a result, Mader Group's ROE is not expected to change by much either, which we inferred from the analyst estimate of 29% for future ROE.

Summary

On the whole, we feel that Mader Group's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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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