It is hard to get excited after looking at Vtech Holdings' (HKG:303) recent performance, when its stock has declined 3.4% over the past week. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Vtech Holdings' ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

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 Vtech Holdings is:

26% = US$161m ÷ US$610m (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.26.

What Has ROE Got To Do With 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. 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.

Vtech Holdings' Earnings Growth And 26% ROE

Firstly, we acknowledge that Vtech Holdings has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 5.4% which is quite remarkable. As you might expect, the 3.6% net income decline reported by Vtech Holdings doesn't bode well with us. 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.

With the industry earnings declining at a rate of 3.6% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Vtech Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Vtech Holdings Making Efficient Use Of Its Profits?

Vtech Holdings has a high three-year median payout ratio of 98% (that is, it is retaining 2.0% 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. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 2 risks we have identified for Vtech Holdings visit our risks dashboard for free.

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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 95% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 28%.

Conclusion

In total, we're a bit ambivalent about Vtech Holdings' performance. In spite of the high ROE, the company has failed to see growth in its earnings due to it paying out most of its profits as dividend, with almost nothing left to invest into its own business. So far, we've only made a quick discussion around the company's earnings growth. 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.