Ross Stores (NASDAQ:ROST) has had a great run on the share market with its stock up by a significant 9.0% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Ross Stores' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Ross Stores is:
37% = US$1.7b ÷ US$4.6b (Based on the trailing twelve months to October 2023).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.37 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. 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.
Ross Stores' Earnings Growth And 37% ROE
First thing first, we like that Ross Stores has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 21% which is quite remarkable. Despite this, Ross Stores' five year net income growth was quite low averaging at only 3.1%. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
As a next step, we compared Ross Stores' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 27% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 ROST? You can find out in our latest intrinsic value infographic research report.
Is Ross Stores Efficiently Re-investing Its Profits?
Despite having a moderate three-year median payout ratio of 27% (implying that the company retains the remaining 73% of its income), Ross Stores' 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.
Moreover, Ross Stores 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 28%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 45%.
Overall, we feel that Ross Stores certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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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.