Could The Market Be Wrong About Reece Limited (ASX:REH) Given Its Attractive Financial Prospects?
With its stock down 6.2% over the past three months, it is easy to disregard Reece (ASX:REH). 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. Particularly, we will be paying attention to Reece's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Reece
How Do You 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 Reece is:
11% = AU$388m ÷ AU$3.6b (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.11 in profit.
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 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 Reece's Earnings Growth And 11% ROE
To begin with, Reece seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 9.5%. Consequently, this likely laid the ground for the decent growth of 17% seen over the past five years by Reece.
Next, on comparing with the industry net income growth, we found that Reece's reported growth was lower than the industry growth of 26% over the last few years, which is not something we like 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. Doing so will help them establish if the stock's future looks promising or ominous. Is Reece fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Reece Making Efficient Use Of Its Profits?
With a three-year median payout ratio of 37% (implying that the company retains 63% of its profits), it seems that Reece is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Moreover, Reece 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 41%. Accordingly, forecasts suggest that Reece's future ROE will be 10% which is again, similar to the current ROE.
Conclusion
On the whole, we feel that Reece's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
