News (NASDAQ:NWSA) has had a rough month with its share price down 9.4%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study News’ ROE in this article.
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 Do You 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 News is:
8.3% = US$760m ÷ US$9.1b (Based on the trailing twelve months to June 2022).
The ‘return’ refers to a company’s earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
News’ Earnings Growth And 8.3% ROE
At first glance, News’ ROE doesn’t look very promising. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 14% either. Despite this, surprisingly, News saw an exceptional 44% net income growth over the past five years. We reckon that there could be other factors at play here. Such as – high earnings retention or an efficient management in place.
We then compared News’ 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 2.4% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 News is trading on a high P/E or a low P/E, relative to its industry.
Is News Using Its Retained Earnings Effectively?
News has a really low LTM (or last twelve month) payout ratio of 19%, meaning that it has the remaining 81% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Additionally, News has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 18% of its profits over the next three years. Accordingly, forecasts suggest that News’ future ROE will be 7.1% which is again, similar to the current ROE.
In total, it does look like News has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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