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Could The Market Be Wrong About Brickworks Limited (ASX:BKW) Given Its Attractive Financial Prospects?

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·4 min read
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With its stock down 4.4% over the past three months, it is easy to disregard Brickworks (ASX:BKW). 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 Brickworks' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Brickworks

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 Brickworks is:

13% = AU$315m ÷ AU$2.4b (Based on the trailing twelve months to July 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$0.13.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Brickworks' Earnings Growth And 13% ROE

To begin with, Brickworks seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.8%. Probably as a result of this, Brickworks was able to see a decent growth of 19% over the last five years.

When you consider the fact that the industry earnings have shrunk at a rate of 6.2% in the same period, the company's net income growth is pretty remarkable.

past-earnings-growth
past-earnings-growth

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. Is Brickworks fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Brickworks Making Efficient Use Of Its Profits?

Brickworks has a healthy combination of a moderate three-year median payout ratio of 42% (or a retention ratio of 58%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, Brickworks 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 63% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 6.0%, over the same period.

Conclusion

In total, we are pretty happy with Brickworks' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.