It is hard to get excited after looking at Visa's (NYSE:V) recent performance, when its stock has declined 3.9% over the past week. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Visa's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Visa is:
33% = US$12b ÷ US$36b (Based on the trailing twelve months to June 2020).
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 $0.33.
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.
Visa's Earnings Growth And 33% ROE
Firstly, we acknowledge that Visa has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. This likely paved the way for the modest 18% net income growth seen by Visa over the past five years. growth
We then compared Visa's 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 10% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Visa fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Visa Making Efficient Use Of Its Profits?
Visa has a low three-year median payout ratio of 20%, meaning that the company retains the remaining 80% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Besides, Visa has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 19%. However, Visa's ROE is predicted to rise to 41% despite there being no anticipated change in its payout ratio.
In total, we are pretty happy with Visa's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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. 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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