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Are Robust Financials Driving The Recent Rally In Costco Wholesale Corporation's (NASDAQ:COST) Stock?

Simply Wall St
·4 min read

Costco Wholesale's (NASDAQ:COST) stock is up by a considerable 5.8% over the past week. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Costco Wholesale's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Costco Wholesale

How To Calculate Return On Equity?

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 Costco Wholesale is:

28% = US$5.9b ÷ US$21b (Based on the trailing twelve months to November 2022).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.28 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. 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.

Costco Wholesale's Earnings Growth And 28% ROE

First thing first, we like that Costco Wholesale has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. This probably laid the groundwork for Costco Wholesale's moderate 15% net income growth seen over the past five years.

As a next step, we compared Costco Wholesale's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 13% 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. 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. Has the market priced in the future outlook for COST? You can find out in our latest intrinsic value infographic research report.

Is Costco Wholesale Making Efficient Use Of Its Profits?

Costco Wholesale has a three-year median payout ratio of 27%, which implies that it retains the remaining 73% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Costco Wholesale is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 20% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

In total, we are pretty happy with Costco Wholesale's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

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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