It is hard to get excited after looking at K-Bro Linen's (TSE:KBL) recent performance, when its stock has declined 13% over the past three months. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Particularly, we will be paying attention to K-Bro Linen's ROE today.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 K-Bro Linen is:
2.9% = CA$5.1m ÷ CA$175m (Based on the trailing twelve months to September 2022).
The 'return' is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.03 in profit.
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. 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.
K-Bro Linen's Earnings Growth And 2.9% ROE
It is hard to argue that K-Bro Linen's ROE is much good in and of itself. Not just that, even compared to the industry average of 8.4%, the company's ROE is entirely unremarkable. Therefore, K-Bro Linen's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
As a next step, we compared K-Bro Linen's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.5% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for KBL? You can find out in our latest intrinsic value infographic research report.
Is K-Bro Linen Efficiently Re-investing Its Profits?
K-Bro Linen has a three-year median payout ratio as high as 180% meaning that the company is paying a dividend which is beyond its means. The absence of growth in K-Bro Linen's earnings therefore, doesn't come as a surprise. Its usually very hard to sustain dividend payments that are higher than reported profits. That's a huge risk in our books. To know the 2 risks we have identified for K-Bro Linen visit our risks dashboard for free.
Moreover, K-Bro Linen has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
In total, we would have a hard think before deciding on any investment action concerning K-Bro Linen. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
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