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Are Robust Financials Driving The Recent Rally In Burberry Group plc's (LON:BRBY) Stock?

·4 min read

Most readers would already be aware that Burberry Group's (LON:BRBY) stock increased significantly by 14% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Burberry Group'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Burberry Group

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Burberry Group is:

25% = UK£397m ÷ UK£1.6b (Based on the trailing twelve months to April 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.25 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Burberry Group's Earnings Growth And 25% ROE

To begin with, Burberry Group has a pretty high ROE which is interesting. Additionally, a comparison with the average industry ROE of 21% also portrays the company's ROE in a good light. However, for some reason, the higher returns aren't reflected in Burberry Group's meagre five year net income growth average of 3.2%.Despite this, Burberry Group's five year net income growth was quite low averaging at only 3.2%.Yet, Burberry Group has posted measly growth of 3.2% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. A few likely reasons why this could happen is that the company could have a high payout ratio the business has allocated capital poorly, for instance.

We then performed a comparison between Burberry Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 2.7% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is BRBY worth today? The intrinsic value infographic in our free research report helps visualize whether BRBY is currently mispriced by the market.

Is Burberry Group Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 46% (implying that the company retains the remaining 54% of its income), Burberry Group's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Burberry Group 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 53% of its profits over the next three years. Accordingly, forecasts suggest that Burberry Group's future ROE will be 26% which is again, similar to the current ROE.

Summary

In total, we are pretty happy with Burberry Group's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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

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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