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Best Buy (NYSE:BBY) has had a rough month with its share price down 17%. 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. Specifically, we decided to study Best Buy'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Best Buy is:
42% = US$1.7b ÷ US$4.1b (Based on the trailing twelve months to October 2020).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.42.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Best Buy's Earnings Growth And 42% ROE
To begin with, Best Buy has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 16% the company's ROE is quite impressive. Probably as a result of this, Best Buy was able to see a decent net income growth of 12% over the last five years.
We then compared Best Buy's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.3% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for BBY? You can find out in our latest intrinsic value infographic research report.
Is Best Buy Efficiently Re-investing Its Profits?
With a three-year median payout ratio of 35% (implying that the company retains 65% of its profits), it seems that Best Buy is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Moreover, Best Buy 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 over the next three years is expected to be approximately 30%. However, Best Buy's ROE is predicted to rise to 81% despite there being no anticipated change in its payout ratio.
Overall, we are quite pleased with Best Buy'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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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