Vtech Holdings' (HKG:303) stock is up by a considerable 27% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Vtech Holdings' ROE today.

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 Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Vtech Holdings is:

26% = US$167m ÷ US$645m (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.26.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of Vtech Holdings' Earnings Growth And 26% ROE

First thing first, we like that Vtech Holdings has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 5.3% also doesn't go unnoticed by us. For this reason, Vtech Holdings' five year net income decline of 4.4% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

That being said, we compared Vtech Holdings' 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 4.4% in the same 5-year 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). Doing so will help them establish if the stock's future looks promising or ominous. What is 303 worth today? The intrinsic value infographic in our free research report helps visualize whether 303 is currently mispriced by the market.

Is Vtech Holdings Making Efficient Use Of Its Profits?

Vtech Holdings has a high three-year median payout ratio of 99% (that is, it is retaining 1.4% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 2 risks we have identified for Vtech Holdings visit our risks dashboard for free.

Additionally, Vtech Holdings has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 105% of its profits over the next three years. Regardless, the future ROE for Vtech Holdings is predicted to rise to 32% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we have mixed feelings about Vtech Holdings. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Vtech Holdings' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com