GUD Holdings Limited's (ASX:GUD) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?
GUD Holdings (ASX:GUD) has had a rough month with its share price down 7.7%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to GUD Holdings' 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for GUD Holdings
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for GUD Holdings is:
12% = AU$107m ÷ AU$909m (Based on the trailing twelve months to December 2023).
The 'return' is the profit 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$0.12 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
GUD Holdings' Earnings Growth And 12% ROE
To start with, GUD Holdings' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 12%. This probably goes some way in explaining GUD Holdings' moderate 10% growth over the past five years amongst other factors.
Next, on comparing with the industry net income growth, we found that GUD Holdings' reported growth was lower than the industry growth of 13% over the last few years, which is not something we like to see.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is GUD fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is GUD Holdings Making Efficient Use Of Its Profits?
GUD Holdings has a significant three-year median payout ratio of 87%, meaning that it is left with only 13% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Additionally, GUD Holdings has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 56% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
Summary
In total, it does look like GUD Holdings has some positive aspects to its business. 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
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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.
