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Are Strong Financial Prospects The Force That Is Driving The Momentum In GUD Holdings Limited's ASX:GUD) Stock?

Simply Wall St

GUD Holdings (ASX:GUD) has had a great run on the share market with its stock up by a significant 37% over the last 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 GUD Holdings' 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.

See our latest analysis for GUD Holdings

How Do You 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 GUD Holdings is:

20% = AU$57m ÷ AU$278m (Based on the trailing twelve months to December 2019).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.20.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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.

GUD Holdings' Earnings Growth And 20% ROE

To start with, GUD Holdings' ROE looks acceptable. On comparing with the average industry ROE of 7.3% the company's ROE looks pretty remarkable. This certainly adds some context to GUD Holdings' decent 16% net income growth seen over the past five years.

We then performed a comparison between GUD Holdings' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 16% in the same period.

ASX:GUD Past Earnings Growth June 26th 2020

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about GUD Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is GUD Holdings Efficiently Re-investing Its Profits?

While GUD Holdings has a three-year median payout ratio of 85% (which means it retains 15% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Besides, GUD Holdings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 81% of its profits over the next three years. As a result, GUD Holdings' ROE is not expected to change by much either, which we inferred from the analyst estimate of 19% for future ROE.

Conclusion

Overall, we are quite pleased with GUD Holdings' performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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.

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