Could The Market Be Wrong About Volution Group plc (LON:FAN) Given Its Attractive Financial Prospects?

Simply Wall St
·4-min read

With its stock down 9.2% over the past month, it is easy to disregard Volution Group (LON:FAN). 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. Specifically, we decided to study Volution 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Volution 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 Volution Group is:

11% = UK£20m ÷ UK£174m (Based on the trailing twelve months to January 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.11 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 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.

Volution Group's Earnings Growth And 11% ROE

To start with, Volution Group's ROE looks acceptable. Even when compared to the industry average of 12% the company's ROE looks quite decent. This probably goes some way in explaining Volution Group's moderate 14% growth over the past five years amongst other factors.

Next, on comparing with the industry net income growth, we found that Volution Group's growth is quite high when compared to the industry average growth of 9.3% in the same period, which is great to see.

LSE:FAN Past Earnings Growth July 10th 2020
LSE:FAN Past Earnings Growth July 10th 2020

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is FAN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Volution Group Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 58% (or a retention ratio of 42%) for Volution Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 30% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Summary

In total, we are pretty happy with Volution Group's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Volution Group's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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