Yahoo Finance Is Auto Trader Group plc's (LON:AUTO) Latest Stock Performance Being Led By Its Strong Fundamentals?
Most readers would already know that Auto Trader Group's (LON:AUTO) stock increased by 5.6% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Auto Trader Group's ROE in this article.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Auto Trader Group
How To 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 Auto Trader Group is:
44% = UK£236m ÷ UK£540m (Based on the trailing twelve months to September 2023).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.44 in profit.
What Is The Relationship Between ROE And 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.
A Side By Side comparison of Auto Trader Group's Earnings Growth And 44% ROE
Firstly, we acknowledge that Auto Trader Group has a significantly high ROE. Secondly, even when compared to the industry average of 8.1% the company's ROE is quite impressive. This probably laid the groundwork for Auto Trader Group's moderate 5.7% net income growth seen over the past five years.
We then compared Auto Trader Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 18% in the same 5-year period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is AUTO fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Auto Trader Group Using Its Retained Earnings Effectively?
With a three-year median payout ratio of 34% (implying that the company retains 66% of its profits), it seems that Auto Trader Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Moreover, Auto Trader Group is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 32%. Accordingly, forecasts suggest that Auto Trader Group's future ROE will be 51% which is again, similar to the current ROE.
Conclusion
Overall, we are quite pleased with Auto Trader Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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.
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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.