It is hard to get excited after looking at Karooooo's (NASDAQ:KARO) recent performance, when its stock has declined 4.9% 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. In this article, we decided to focus on Karooooo's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

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 Karooooo is:

32% = R855m ÷ R2.7b (Based on the trailing twelve months to August 2024).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.32 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Karooooo's Earnings Growth And 32% ROE

Firstly, we acknowledge that Karooooo has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. As a result, Karooooo's exceptional 25% net income growth seen over the past five years, doesn't come as a surprise.

As a next step, we compared Karooooo'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 20%.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Karooooo's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Karooooo Making Efficient Use Of Its Profits?

Karooooo's significant three-year median payout ratio of 69% (where it is retaining only 31% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Additionally, Karooooo has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with 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 69%. Accordingly, forecasts suggest that Karooooo's future ROE will be 29% which is again, similar to the current ROE.

Summary

On the whole, we feel that Karooooo's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.