Most readers would already be aware that Goodman Group's (ASX:GMG) stock increased significantly by 22% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Goodman Group's ROE.
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 Do You 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 Goodman Group is:
13% = AU$1.5b ÷ AU$12b (Based on the trailing twelve months to June 2020).
The 'return' is the yearly profit. 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. 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. 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 Goodman Group's Earnings Growth And 13% ROE
To start with, Goodman Group's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 6.6%. This certainly adds some context to Goodman Group's decent 5.3% net income growth seen over the past five years.
We then compared Goodman Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.5% in the same period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for GMG? You can find out in our latest intrinsic value infographic research report.
Is Goodman Group Making Efficient Use Of Its Profits?
Goodman Group seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 58%, meaning the company retains only 42% of its income. However, this is typical for REITs as they are often required by law to distribute most of their earnings. Despite this, the company's earnings grew moderately as we saw above.
Moreover, Goodman Group 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 49%. Accordingly, forecasts suggest that Goodman Group's future ROE will be 11% which is again, similar to the current ROE.
Overall, we feel that Goodman Group certainly does have some positive factors to consider. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. 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.
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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