It is hard to get excited after looking at Zoom Video Communications' (NASDAQ:ZM) recent performance, when its stock has declined 21% over the past three months. 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 Zoom Video Communications' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Zoom Video Communications is:
21% = US$1.3b ÷ US$5.9b (Based on the trailing twelve months to April 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.21 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. 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 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.
Zoom Video Communications' Earnings Growth And 21% ROE
To start with, Zoom Video Communications' ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Probably as a result of this, Zoom Video Communications was able to see an impressive net income growth of 84% over the last five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Zoom Video Communications' 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 25%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is ZM worth today? The intrinsic value infographic in our free research report helps visualize whether ZM is currently mispriced by the market.
Is Zoom Video Communications Making Efficient Use Of Its Profits?
Zoom Video Communications doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.
Overall, we are quite pleased with Zoom Video Communications' performance. 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.