Yahoo Finance Is The Market Rewarding Mears Group plc (LON:MER) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?
With its stock down 6.3% over the past month, it is easy to disregard Mears Group (LON:MER). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Mears Group's 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.
View our latest analysis for Mears Group
How Is ROE Calculated?
ROE 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 Mears Group is:
2.7% = UK£4.8m ÷ UK£177m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.03 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 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 Mears Group's Earnings Growth And 2.7% ROE
As you can see, Mears Group's ROE looks pretty weak. Even compared to the average industry ROE of 8.6%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 39% seen by Mears Group was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Mears 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 5.0% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is MER fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Mears Group Efficiently Re-investing Its Profits?
Looking at its three-year median payout ratio of 45% (or a retention ratio of 55%) which is pretty normal, Mears Group's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, Mears Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 44%. Still, forecasts suggest that Mears Group's future ROE will rise to 14% even though the the company's payout ratio is not expected to change by much.
Conclusion
In total, we're a bit ambivalent about Mears Group's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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