With its stock down 12% over the past three months, it is easy to disregard Vtech Holdings (HKG:303). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Vtech Holdings' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Vtech Holdings

How Is ROE Calculated?

ROE 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 Vtech Holdings is:

25% = US$173m ÷ US$679m (Based on the trailing twelve months to March 2022).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.25 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Vtech Holdings' Earnings Growth And 25% ROE

To begin with, Vtech Holdings has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 8.1% also doesn't go unnoticed by us. However, we are curious as to how the high returns still resulted in a flat growth for Vtech Holdings in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, we compared Vtech Holdings' performance against the industry and found that the industry shrunk its earnings at 14% in the same period, which suggests that the company's earnings have been shrinking at a slower rate than its industry, While this is not particularly good, its not particularly bad either.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 91% (meaning, the company retains only 9.1% of profits) for Vtech Holdings suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

Moreover, Vtech Holdings has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 98%. Accordingly, forecasts suggest that Vtech Holdings' future ROE will be 30% which is again, similar to the current ROE.

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. Up till now, we've only made a short study of the company's growth data. You can do your own research on Vtech Holdings and see how it has performed in the past by looking at this FREE detailed graph 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.