With its stock down 15% over the past three months, it is easy to disregard Vipshop Holdings (NYSE:VIPS). 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 Vipshop Holdings' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Vipshop Holdings

How To Calculate Return On 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 Vipshop Holdings is:

21% = CN¥8.5b ÷ CN¥40b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Vipshop Holdings' Earnings Growth And 21% ROE

At first glance, Vipshop Holdings seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 21%. Consequently, this likely laid the ground for the decent growth of 17% seen over the past five years by Vipshop Holdings.

We then performed a comparison between Vipshop 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 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Vipshop Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is Vipshop Holdings Using Its Retained Earnings Effectively?

In Vipshop Holdings' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 20% (or a retention ratio of 80%), which suggests that the company is investing most of its profits to grow its business.

While Vipshop Holdings has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 38% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 15%) over the same period.

Summary

Overall, we are quite pleased with Vipshop Holdings' 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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.