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Most readers would already be aware that People Infrastructure's (ASX:PPE) stock increased significantly by 11% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to People Infrastructure's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 People Infrastructure is:
15% = AU$18m ÷ AU$115m (Based on the trailing twelve months to June 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.15 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
People Infrastructure's Earnings Growth And 15% ROE
To start with, People Infrastructure's ROE looks acceptable. Yet, the fact that the company's ROE is lower than the industry average of 21% does temper our expectations. However, we are pleased to see the impressive 45% net income growth reported by People Infrastructure over the past five years. Therefore, there could be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this certainly also provides some context to the high earnings growth seen by the company.
Next, on comparing with the industry net income growth, we found that People Infrastructure's growth is quite high when compared to the industry average growth of 17% 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 People Infrastructure fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is People Infrastructure Using Its Retained Earnings Effectively?
People Infrastructure has a three-year median payout ratio of 47% (where it is retaining 53% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like People Infrastructure is reinvesting its earnings efficiently.
Besides, People Infrastructure has been paying dividends over a period of three years. 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 42%. Regardless, the future ROE for People Infrastructure is predicted to rise to 23% despite there being not much change expected in its payout ratio.
In total, we are pretty happy with People Infrastructure's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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