Marks and Spencer Group's (LON:MKS) stock is up by a considerable 27% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Marks and Spencer Group's ROE in this article.

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 shareholder's equity.

View our latest analysis for Marks and Spencer Group

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Marks and Spencer Group is:

15% = UK￡425m ÷ UK￡2.8b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. So, this means that for every ￡1 of its shareholder's investments, the company generates a profit of ￡0.15.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Marks and Spencer Group's Earnings Growth And 15% ROE

To start with, Marks and Spencer Group's ROE looks acceptable. Even when compared to the industry average of 16% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 50% seen over the past five years by Marks and Spencer Group. We reckon that there could also be other factors at play here. 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.

Next, on comparing with the industry net income growth, we found that Marks and Spencer Group's growth is quite high when compared to the industry average growth of 19% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is MKS worth today? The intrinsic value infographic in our free research report helps visualize whether MKS is currently mispriced by the market.

Is Marks and Spencer Group Using Its Retained Earnings Effectively?

Marks and Spencer Group's three-year median payout ratio to shareholders is 7.1%, which is quite low. This implies that the company is retaining 93% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, Marks and Spencer Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 27% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

In total, we are pretty happy with Marks and Spencer Group's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.