Warehouse Group's (NZSE:WHS) stock up by 2.5% over the past month. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Warehouse Group's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Warehouse Group is:
16% = NZ$60m ÷ NZ$365m (Based on the trailing twelve months to January 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.16 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. 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.
Warehouse Group's Earnings Growth And 16% ROE
To start with, Warehouse Group's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. For this reason, Warehouse Group's five year net income decline of 5.8% raises the question as to why the decent ROE didn't translate into growth. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
However, when we compared Warehouse Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 0.9% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. 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. Is Warehouse Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Warehouse Group Making Efficient Use Of Its Profits?
With a high three-year median payout ratio of 85% (implying that 15% of the profits are retained), most of Warehouse Group's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.
Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 68% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
In total, it does look like Warehouse Group has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
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