VSE Corporation (NASDAQ:VSEC) stock is up but financial data looks ambiguous: will the momentum continue?
VSE (NASDAQ:VSEC) stock is up 26% over the past month. However, we decided to pay attention to the fundamentals of the company which do not seem to give a clear indication of the financial health of the company. Specifically, we decided to study the ROE of VSE in this article.
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
How do you calculate return on equity?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for VSE is:
6.7% = $29m ÷ $431m (based on trailing 12 months to June 2022).
The “yield” is the amount earned after tax over the last twelve months. This therefore means that for every $1 of investment by its shareholder, the company generates a profit of $0.07.
Why is ROE important for earnings growth?
So far, we have learned that ROE measures how efficiently a company generates its profits. Depending on how much of its profits the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
VSE and ROE earnings growth of 6.7%
When you first look at it, VSE’s ROE doesn’t look so appealing. Then, compared to the industry average ROE of 12%, the company’s ROE leaves us even less excited. For this reason, VSE’s 31% drop in net income over five years is not surprising given its low ROE. We believe there could be other factors at play here as well. Such as – low income retention or poor capital allocation.
However, when we compared VSE’s growth with the industry, we found that although the company’s earnings declined, the industry experienced earnings growth of 3.0% over the same period. period. It’s quite worrying.
Earnings growth is an important factor in stock valuation. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. By doing so, he will get an idea if the title is heading for clear blue waters or if swampy waters await. A 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 outlook. Thus, you might want to check whether VSE is trading on a high P/E or on a low P/E, relative to its industry.
Is VSE using its profits effectively?
VSE’s low three-year median payout ratio of 12% (implying it keeps the remaining 88% of its earnings) comes as a surprise when you pair it with declining earnings. This should generally not be the case when a company retains most of its profits. So there could be other explanations for this. For example, the company’s business may deteriorate.
Additionally, VSE has paid dividends over a period of at least ten years, which means the company’s management is committed to paying dividends even if it means little or no earnings growth.
Overall, we have mixed feelings about VSE. Even though it seems to keep most of its profits, given the low ROE, investors may not be benefiting from all that reinvestment after all. Weak earnings growth suggests our theory is correct. That said, looking at current analyst estimates, we found that the company’s earnings growth rate should see a huge improvement. To learn more about the latest analyst forecasts for the company, check out this analyst forecast visualization for the company.
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