It is hard to get excited after looking at Paylocity Holding’s (NASDAQ:PCTY) recent performance, when its stock has declined 17% over the past three months. 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. Particularly, we will be paying attention to Paylocity Holding’s ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
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 Paylocity Holding is:
16% = US$67m ÷ US$408m (Based on the trailing twelve months to December 2020).
The ‘return’ is the profit over the last twelve months. That means that for every $1 worth of shareholders’ equity, the company generated $0.16 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. 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.
Paylocity Holding’s Earnings Growth And 16% ROE
At first glance, Paylocity Holding seems to have a decent ROE. Further, the company’s ROE compares quite favorably to the industry average of 12%. Probably as a result of this, Paylocity Holding was able to see an impressive net income growth of 53% over the last five years. We reckon that there could also be other factors at play here. Such as – high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Paylocity Holding’s growth is quite high when compared to the industry average growth of 28% 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. This then helps them determine if the stock is placed for a bright or bleak future. Is Paylocity Holding fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Paylocity Holding Efficiently Re-investing Its Profits?
Overall, we are quite pleased with Paylocity Holding’s performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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. 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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