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Is Reece Limited's (ASX:REH) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

Most readers would already be aware that Reece's (ASX:REH) stock increased significantly by 13% 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. Particularly, we will be paying attention to Reece's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Reece

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 Reece is:

8.3% = AU$229m ÷ AU$2.7b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Reece's Earnings Growth And 8.3% ROE

On the face of it, Reece's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 5.2% doesn't go unnoticed by us. However, Reece's five year net income growth was quite low averaging at only 5.0%. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to stay low.

Next, on comparing with the industry net income growth, we found that Reece's reported growth was lower than the industry growth of 37% in the same period, which is not something we like to see.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Reece's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Reece Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 47% (implying that the company retains the remaining 53% of its income), Reece's earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Reece 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 42%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 8.4%.

Summary

On the whole, we do feel that Reece has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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