Yahoo Finance Auto Trader Group plc (LON:AUTO) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?
With its stock down 12% over the past three months, it is easy to disregard Auto Trader Group (LON:AUTO). 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. In this article, we decided to focus on Auto Trader Group's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Auto Trader Group
How To Calculate Return On Equity?
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 Auto Trader Group is:
46% = UK£238m ÷ UK£523m (Based on the trailing twelve months to September 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.46 in profit.
What Is The Relationship Between ROE And 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.
Auto Trader Group's Earnings Growth And 46% ROE
First thing first, we like that Auto Trader Group has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 29% which is quite remarkable. Despite this, Auto Trader Group's five year net income growth was quite low averaging at only 4.7%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.
As a next step, we compared Auto Trader Group's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 4.7% in the same period.
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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for AUTO? You can find out in our latest intrinsic value infographic research report.
Is Auto Trader Group Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 32% (implying that the company retains the remaining 68% of its income), Auto Trader Group's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Moreover, Auto Trader Group has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 33%. Accordingly, forecasts suggest that Auto Trader Group's future ROE will be 47% which is again, similar to the current ROE.
Summary
In total, we are pretty happy with Auto Trader Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.
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