Resources Connection, Inc.'s (NASDAQ:RGP) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?
Most readers would already be aware that Resources Connection's (NASDAQ:RGP) stock increased significantly by 18% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Resources Connection's ROE.
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 Resources Connection
How Is ROE Calculated?
Return on equity 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 Resources Connection is:
7.7% = US$25m ÷ US$330m (Based on the trailing twelve months to May 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.08 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Resources Connection's Earnings Growth And 7.7% ROE
At first glance, Resources Connection's ROE doesn't look very promising. Next, when compared to the average industry ROE of 16%, the company's ROE leaves us feeling even less enthusiastic. As a result, Resources Connection's flat net income growth over the past five years doesn't come as a surprise given its lower ROE.
As a next step, we compared Resources Connection's net income growth with the industry and discovered that the industry saw an average growth of 15% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is RGP fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Resources Connection Making Efficient Use Of Its Profits?
Resources Connection has a high three-year median payout ratio of 63% (or a retention ratio of 37%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.
In addition, Resources Connection has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 35% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 11%, over the same period.
Summary
On the whole, Resources Connection's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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. 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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