Over the Wire Holdings' (ASX:OTW) stock is up by a considerable 25% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Over the Wire Holdings' 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. 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 ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Over the Wire Holdings is:
3.4% = AU$3.4m ÷ AU$100m (Based on the trailing twelve months to June 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.03 in profit.
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. 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.
A Side By Side comparison of Over the Wire Holdings' Earnings Growth And 3.4% ROE
It is hard to argue that Over the Wire Holdings' ROE is much good in and of itself. Even when compared to the industry average of 8.0%, the ROE figure is pretty disappointing. However, the moderate 11% net income growth seen by Over the Wire Holdings over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Over the Wire Holdings' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 14% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is OTW worth today? The intrinsic value infographic in our free research report helps visualize whether OTW is currently mispriced by the market.
Is Over the Wire Holdings Using Its Retained Earnings Effectively?
Over the Wire Holdings has a low three-year median payout ratio of 20%, meaning that the company retains the remaining 80% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Besides, Over the Wire Holdings has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 28% over the next three years. However, Over the Wire Holdings' future ROE is expected to rise to 10% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.
On the whole, we do feel that Over the Wire Holdings 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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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