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Breville Group Limited's (ASX:BRG) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

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Breville Group's (ASX:BRG) stock is up by a considerable 7.2% over the past month. 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. Specifically, we decided to study Breville Group's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Breville Group

How To Calculate Return On Equity?

ROE 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 Breville Group is:

16% = AU$81m ÷ AU$489m (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.16 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.

Breville Group's Earnings Growth And 16% ROE

To begin with, Breville Group seems to have a respectable ROE. Even so, when compared with the average industry ROE of 21%, we aren't very excited. Breville Group was still able to see a decent net income growth of 9.6% over the past five years. So, there might be other aspects that are positively influencing earnings growth. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the fairly high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Breville Group's growth is quite high when compared to the industry average growth of 7.9% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Breville Group is trading on a high P/E or a low P/E, relative to its industry.

Is Breville Group Using Its Retained Earnings Effectively?

Breville Group has a significant three-year median payout ratio of 71%, meaning that it is left with only 29% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Breville Group 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 41% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 20%, over the same period.

Conclusion

In total, it does look like Breville Group has some positive aspects to its business. Namely, its significant earnings growth, to which its moderate rate of return likely contributed. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.