With its stock down 6.9% over the past month, it is easy to disregard Ermenegildo Zegna (NYSE:ZGN). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Ermenegildo Zegna's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Ermenegildo Zegna

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 Ermenegildo Zegna is:

13% = €115m ÷ €914m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.13 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Ermenegildo Zegna's Earnings Growth And 13% ROE

To start with, Ermenegildo Zegna's ROE looks acceptable. Even when compared to the industry average of 13% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 46% seen over the past five years by Ermenegildo Zegna. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Ermenegildo Zegna's growth is quite high when compared to the industry average growth of 22% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Ermenegildo Zegna is trading on a high P/E or a low P/E, relative to its industry.

Is Ermenegildo Zegna Using Its Retained Earnings Effectively?

Ermenegildo Zegna's three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. So it seems that Ermenegildo Zegna is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, Ermenegildo Zegna has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 37% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

Overall, we are quite pleased with Ermenegildo Zegna's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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 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.