Are Knights Group Holdings plc's (LON:KGH) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

editorial-team@simplywallst.com (Simply Wall St)

Wed, Oct 9, 2024, 3:32 AM 4 min read

Knights Group Holdings (LON:KGH) has had a rough three months with its share price down 7.4%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Knights Group Holdings' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Knights Group Holdings

How Do You 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 Knights Group Holdings is:

9.8% = UK£9.8m ÷ UK£100m (Based on the trailing twelve months to April 2024).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Knights Group Holdings' Earnings Growth And 9.8% ROE

On the face of it, Knights Group Holdings' ROE is not much to talk about. Next, when compared to the average industry ROE of 13%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Knights Group Holdings grew its net income at a significant rate of 30% in the last five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Knights Group Holdings' 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 9.8% in the same 5-year period.

past-earnings-growth — AIM:KGH Past Earnings Growth October 9th 2024

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Knights Group Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Knights Group Holdings Making Efficient Use Of Its Profits?

Knights Group Holdings has a three-year median payout ratio of 38% (where it is retaining 62% of its income) which is not too low or not too high. So it seems that Knights Group Holdings is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Knights Group Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 20% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 16%, over the same period.

Summary

In total, it does look like Knights Group Holdings has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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.