It is hard to get excited after looking at PayPal Holdings’ (NASDAQ:PYPL) recent performance, when its stock has declined 15% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on PayPal Holdings’ ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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How To Calculate Return On Equity?
Return on equity 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 PayPal Holdings is:
11% = US$2.3b ÷ US$20b (Based on the trailing twelve months to September 2022).
The ‘return’ is the yearly profit. That means that for every $1 worth of shareholders’ equity, the company generated $0.11 in profit.
What Has ROE Got To Do With 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 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.
PayPal Holdings’ Earnings Growth And 11% ROE
To begin with, PayPal Holdings seems to have a respectable ROE. Be that as it may, the company’s ROE is still quite lower than the industry average of 15%. PayPal Holdings was still able to see a decent net income growth of 16% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. Such as – high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also provides some context to the earnings growth seen by the company.
We then performed a comparison between PayPal Holdings’ net income growth with the industry, which revealed that the company’s growth is similar to the average industry growth of 15% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. What is PYPL worth today? The intrinsic value infographic in our free research report helps visualize whether PYPL is currently mispriced by the market.
Is PayPal Holdings Efficiently Re-investing Its Profits?
PayPal Holdings doesn’t pay any dividend, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.
Summary
On the whole, we feel that PayPal Holdings’ performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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Find out whether PayPal Holdings is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.
Read More: PayPal Holdings, Inc.’s (NASDAQ:PYPL) Fundamentals Look Pretty Strong: Could The Market