It is hard to get excited after looking at Masterflex’s (ETR:MZX) recent performance, when its stock has declined 3.6% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Masterflex’s ROE today.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
View our latest analysis for Masterflex
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Masterflex is:
5.8% = €2.4m ÷ €42m (Based on the trailing twelve months to December 2019).
The ‘return’ is the yearly profit. That means that for every €1 worth of shareholders’ equity, the company generated €0.06 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we’ve learnt 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.
Masterflex’s Earnings Growth And 5.8% ROE
When you first look at it, Masterflex’s ROE doesn’t look that attractive. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 10% either. Masterflex was still able to see a decent net income growth of 6.0% over the past five years. So, the growth in the company’s earnings could probably have been caused by other variables. 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.
Next, on comparing with the industry net income growth, we found that Masterflex’s reported growth was lower than the industry growth of 11% in the same period, which is not something we like to see.
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. Doing so will help them establish if the stock’s future looks promising or ominous. 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 Masterflex is trading on a high P/E or a low P/E, relative to its industry.
Is Masterflex Using Its Retained Earnings Effectively?
Masterflex has a low three-year median payout ratio of 15%, meaning that the company retains the remaining 85% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Moreover, Masterflex is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.
On the whole, we do feel that Masterflex has some positive attributes. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. With that said, the latest industry analyst forecasts reveal that the company’s earnings are expected to accelerate. 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.
If you spot an error that warrants correction, please contact the editor at [email protected] 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. Simply Wall St has no position in the stocks mentioned.
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