Can Zytronic plc’s (LON:ZYT)’s weak financials pull the plug on the stock’s current momentum on the share price?

Zytronic (LON:ZYT) has had a great run in the stock market, with the stock up a whopping 13% over the past week. However, we have chosen to pay particular attention to the weak financial data as we doubt the current momentum will continue given the scenario. Today we are paying particular attention to Zytronic’s ROE.

Return on Equity, or ROE, is a key metric used to assess how efficiently a company’s management is using the company’s capital. In other words, it shows the company’s success in turning shareholders’ investments into profits.

Check out our latest analysis for Zytronic

How do you calculate return on equity?

The return on equity can be calculated using the following formula:

Return on Equity = Net Income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE for Zytronic is:

2.4% = £406,000 ÷ £17 million (based on trailing 12 months to September 2021).

“Yield” refers to a company’s profits over the last year. So this means that for every £1 of investment by its shareholders, the company makes £0.02 of profit.

Why is ROE important for earnings growth?

So far we’ve learned that ROE is a measure of a company’s profitability. We now need to evaluate how much profit the company is reinvesting or “keeping” for future growth, which then gives us an idea of ​​the company’s growth potential. Assuming all else remains the same, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.

Zytronic earnings growth and 2.4% ROE

It’s hard to argue that Zytronic’s ROE is very good in and of itself. Even compared to the industry average ROE of 14%, the company’s ROE is pretty dismal. Given the circumstances, the sharp 42% drop in net income that Zytronic has seen over the past five years isn’t surprising. However, other factors can also cause earnings to fall. Such as – low earnings retention or poor capital allocation.

As a next step, we compared Zytronic’s performance to the industry and were disappointed to find that the industry increased earnings by 0.5% over the same period while the company shrank earnings.

AIM:ZYT Past Earnings Growth February 23, 2022

Much of the basis for increasing the value of a company is 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). This then helps them determine if the stock is placed for a bright or bleak future. A good indicator of expected earnings growth is the price-to-earnings ratio, which determines the price the market is willing to pay for a stock based on its earnings prospects. So you should check whether Zytronic is trading at a high P/E or low P/E relative to its industry.

Is Zytronic using its profits efficiently?

With a three-year median payout ratio of up to 129%, Zytronic’s shrinking earnings aren’t surprising as the company pays a dividend that’s above its means. It is usually very difficult to maintain dividend payments that are higher than reported earnings. To learn more about the 2 risks we have identified for Zytronic, visit our risk dashboard for free.

Additionally, Zytronic has been paying dividends for at least a decade, suggesting that management must have recognized that shareholders prefer dividends to earnings growth.

Conclusion

Overall, the Zytronic’s performance is a pretty big disappointment. The low ROE coupled with the fact that the company pays out almost if not all of its earnings as dividends has resulted in no or no earnings growth. So far we have only scratched the surface of the company’s past performance by looking at the company’s fundamentals. You can do your own research on Zytronic and see how it’s performed in the past by watching this for FREE detailed graphics past profits, sales and cash flows.

This Simply Wall St article is of a general nature. We provide comments based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.

About Nina Snider

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