“Prada S.p.A. (HKG:1913) has been consistently delivering impressive financial results, raising the question of whether the market has overlooked its potential and undervalued the company.”
With its stock down 21% over the past three months, it is easy to disregard Prada (HKG:1913). 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.
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 simpler terms, it measures the profitability of a company in relation to shareholders’ equity.
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Prada is:
17% = €586m ÷ €3.5b (Based on the trailing twelve months to June 2023).
The ‘return’ is the amount earned after tax over the last twelve months. That means that for every HK$1 worth of shareholders’ equity, the company generated HK$0.17 in profit.
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or “retains” for future growth, which then gives us an idea about the growth potential of the company. 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.
To begin with, Prada seems to have a respectable ROE. Especially when compared to the industry average of 11%, the company’s ROE looks pretty impressive. This probably laid the ground for Prada’s significant 31% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company’s earnings growth, such as high earnings retention or an efficient management in place.
We then compared Prada’s 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 12% in the same 5-year period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock’s future looks promising or ominous. One 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 prospects. So, you may want to check if Prada is trading on a high P/E or a low P/E, relative to its industry.
Prada has a three-year median payout ratio of 48% (where it is retaining 52% of its income), which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Prada is reinvesting its earnings efficiently. Additionally, Prada has paid dividends over a period of at least ten years, which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to rise to 60% over the next three years. However, the company’s ROE is not expected to change much despite the higher expected payout ratio.
On the whole, we feel that Prada’s performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to impressive earnings growth. That being said, a study of the latest analyst forecasts shows that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts’ predictions for the company, check out this visualization of analyst forecasts for the company.
Valuation is complex, but we’re helping make it simple.
Find out whether Prada 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. View the Free Analysis.
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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.