Balfour Beatty (LON:BBY) has had a great run on the share market with its stock up by a significant 13% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Balfour Beatty's ROE today.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To 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 Balfour Beatty is:
2.2% = UK£30m ÷ UK£1.3b (Based on the trailing twelve months to December 2020).
The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.02 in profit.
What Is The Relationship Between ROE And 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.
Balfour Beatty's Earnings Growth And 2.2% ROE
It is hard to argue that Balfour Beatty's ROE is much good in and of itself. Even compared to the average industry ROE of 8.4%, the company's ROE is quite dismal. However, we we're pleasantly surprised to see that Balfour Beatty grew its net income at a significant rate of 40% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Balfour Beatty's growth is quite high when compared to the industry average growth of 17% 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. Is BBY fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Balfour Beatty Making Efficient Use Of Its Profits?
Balfour Beatty has a really low three-year median payout ratio of 15%, meaning that it has the remaining 85% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Moreover, Balfour Beatty is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 29% over the next three years. Still, forecasts suggest that Balfour Beatty's future ROE will rise to 13% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.
On the whole, we do feel that Balfour Beatty has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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