Baby Bunting Group's (ASX:BBN) stock is up by a considerable 11% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Baby Bunting Group's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Baby Bunting Group is:
11% = AU$10.0m ÷ AU$93m (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.11.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Baby Bunting Group's Earnings Growth And 11% ROE
At first glance, Baby Bunting Group seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 17% does temper our expectations. Baby Bunting Group was still able to see a decent net income growth of 9.6% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also provides some context to the earnings growth seen by the company.
We then performed a comparison between Baby Bunting Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 9.6% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. Is BBN fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Baby Bunting Group Using Its Retained Earnings Effectively?
While Baby Bunting Group has a three-year median payout ratio of 82% (which means it retains 18% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Besides, Baby Bunting Group has been paying dividends over a period of four years. 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 over the next three years is expected to be approximately 69%. Still, forecasts suggest that Baby Bunting Group's future ROE will rise to 28% even though the the company's payout ratio is not expected to change by much.
In total, it does look like Baby Bunting Group has some positive aspects to its business. Specifically, its respectable ROE which likely led to the considerable growth in earnings. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
This article by Simply Wall St is general in nature. 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.
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