Ermenegildo Zegna (NYSE:ZGN) has had a rough three months with its share price down 9.5%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Ermenegildo Zegna's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
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 Ermenegildo Zegna is:
15% = €136m ÷ €901m (Based on the trailing twelve months to December 2023).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.15 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Ermenegildo Zegna's Earnings Growth And 15% ROE
To begin with, Ermenegildo Zegna seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. Probably as a result of this, Ermenegildo Zegna was able to see a decent growth of 20% over the last five years.
Next, on comparing with the industry net income growth, we found that Ermenegildo Zegna's growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Ermenegildo Zegna's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Ermenegildo Zegna Using Its Retained Earnings Effectively?
In Ermenegildo Zegna's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 24% (or a retention ratio of 76%), which suggests that the company is investing most of its profits to grow its business.
While Ermenegildo Zegna has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 33% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.
Summary
On the whole, we feel that Ermenegildo Zegna's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.