Yahoo Finance Are Pearson plc's (LON:PSON) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?
Pearson (LON:PSON) has had a rough three months with its share price down 25%. 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 Pearson'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Pearson
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 Pearson is:
6.9% = UK£280m ÷ UK£4.0b (Based on the trailing twelve months to June 2021).
The 'return' is the profit over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.07.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
Pearson's Earnings Growth And 6.9% ROE
On the face of it, Pearson's ROE is not much to talk about. However, its ROE is similar to the industry average of 8.5%, so we won't completely dismiss the company. Moreover, we are quite pleased to see that Pearson's net income grew significantly at a rate of 57% over the last five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Pearson's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.6%.
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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Pearson's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Pearson Making Efficient Use Of Its Profits?
The three-year median payout ratio for Pearson is 48%, which is moderately low. The company is retaining the remaining 52%. So it seems that Pearson is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Besides, Pearson has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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 45%. As a result, Pearson's ROE is not expected to change by much either, which we inferred from the analyst estimate of 7.4% for future ROE.
Summary
On the whole, we do feel that Pearson has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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. 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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