Auto Trader Group’s (LON:AUTO) stock up by 3.4% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Auto Trader Group’s ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To 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 Auto Trader Group is:
28% = UK£128m ÷ UK£459m (Based on the trailing twelve months to March 2021).
The ‘return’ is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.28 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 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 Auto Trader Group’s Earnings Growth And 28% ROE
Firstly, we acknowledge that Auto Trader Group has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 12% also doesn’t go unnoticed by us. Despite this, Auto Trader Group’s five year net income growth was quite low averaging at only 4.0%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn’t been able to do so. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
We then compared Auto Trader Group’s net income growth with the industry and we’re pleased to see that the company’s growth figure is higher when compared with the industry which has a growth rate of 0.8% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you’re wondering about Auto Trader Group’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Auto Trader Group Efficiently Re-investing Its Profits?
Despite having a normal three-year median payout ratio of 32% (or a retention ratio of 68% over the past three years, Auto Trader Group has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Auto Trader Group has paid dividends over a period of six years, which means that the company’s management is determined to pay dividends even if it means little to no 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%. Regardless, the future ROE for Auto Trader Group is predicted to rise to 50% despite there being not much change expected in its payout ratio.
Overall, we are quite pleased with Auto Trader Group’s performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
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