Karooooo's (NASDAQ:KARO) stock is up by a considerable 18% 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 Karooooo'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.

See our latest analysis for Karooooo

How To 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 Karooooo is:

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

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.32 in profit.

What Has ROE Got To Do With Earnings Growth?

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

Karooooo's Earnings Growth And 32% ROE

Firstly, we acknowledge that Karooooo has a significantly high ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. So, the substantial 25% net income growth seen by Karooooo over the past five years isn't overly surprising.

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%.

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 Karooooo fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Karooooo Efficiently Re-investing 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.

Moreover, Karooooo is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 69% of its profits over the next three years. As a result, Karooooo's ROE is not expected to change by much either, which we inferred from the analyst estimate of 29% for future ROE.

Conclusion

Overall, we are quite pleased with Karooooo's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.