With its stock down 4.3% over the past week, it is easy to disregard Midwich Group (LON:MIDW). 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. In this article, we decided to focus on Midwich Group’s ROE.
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. Put another way, it reveals the company’s success at turning shareholder investments into profits.
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 Midwich Group is:
12% = UK£13m ÷ UK£114m (Based on the trailing twelve months to December 2021).
The ‘return’ is the yearly profit. So, this means that for every £1 of its shareholder’s investments, the company generates a profit of £0.12.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. 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.
Midwich Group’s Earnings Growth And 12% ROE
To start with, Midwich Group’s ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. However, while Midwich Group has a pretty respectable ROE, its five year net income decline rate was 17% . Based on this, we feel that there might be other reasons which haven’t been discussed so far in this article that could be hampering the company’s growth. These include low earnings retention or poor allocation of capital.
That being said, we compared Midwich Group’s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 0.1% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock’s future looks promising or ominous. What is MIDW worth today? The intrinsic value infographic in our free research report helps visualize whether MIDW is currently mispriced by the market.
Is Midwich Group Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 65% (implying that 35% of the profits are retained), most of Midwich Group’s profits are being paid to shareholders, which explains the company’s shrinking earnings. The business is only left with a small pool of capital to reinvest – A vicious cycle that doesn’t benefit the company in the long-run. To know the 2 risks we have identified for Midwich Group visit our risks dashboard for free.
Moreover, Midwich Group has been paying dividends for six years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 47% over the next three years. The fact that the company’s ROE is expected to rise to 23% over the same period is explained by the drop in the payout ratio.
In total, it does look like Midwich Group has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.