Are Strong Financial Prospects The Force That Is Driving The Momentum In Virco Mfg. Corporation's NASDAQ:VIRC) Stock?

Simply Wall St · 08/30 11:10

Most readers would already be aware that Virco Mfg's (NASDAQ:VIRC) stock increased significantly by 28% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Virco Mfg's ROE in this article.

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.

View our latest analysis for Virco Mfg

How Do You Calculate Return On Equity?

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 Virco Mfg is:

28% = US\$25m ÷ US\$92m (Based on the trailing twelve months to April 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 \$0.28 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of Virco Mfg's Earnings Growth And 28% ROE

Firstly, we acknowledge that Virco Mfg has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. So, the substantial 54% net income growth seen by Virco Mfg over the past five years isn't overly surprising.

We then compared Virco Mfg's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 13% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Virco Mfg is trading on a high P/E or a low P/E, relative to its industry.

Is Virco Mfg Making Efficient Use Of Its Profits?

Virco Mfg's three-year median payout ratio to shareholders is 2.0%, which is quite low. This implies that the company is retaining 98% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Besides, Virco Mfg has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we feel that Virco Mfg's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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.