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With its stock down 28% over the past three months, it is easy to disregard Monro (NASDAQ:MNRO). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Monro's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Monro is:
5.3% = US$38m ÷ US$731m (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.05 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
A Side By Side comparison of Monro's Earnings Growth And 5.3% ROE
When you first look at it, Monro's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. As a result, Monro's flat net income growth over the past five years doesn't come as a surprise given its lower ROE.
We then compared Monro's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 5.6% in the same period, which is a bit concerning.
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. If you're wondering about Monro's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Monro Making Efficient Use Of Its Profits?
Despite having a moderate three-year median payout ratio of 36% (meaning the company retains64% of profits) in the last three-year period, Monro's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, Monro has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 45% over the next three years.
On the whole, we feel that the performance shown by Monro can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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