Has Wesfarmers Limited (ASX:WES) Stock's Recent Performance Got Anything to Do With Its Financial Health?
Most readers would already know that Wesfarmers' (ASX:WES) stock increased by 4.2% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on Wesfarmers' ROE.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Wesfarmers
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 Wesfarmers is:
30% = AU$2.5b ÷ AU$8.3b (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.30 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Wesfarmers' Earnings Growth And 30% ROE
First thing first, we like that Wesfarmers has an impressive ROE. Secondly, even when compared to the industry average of 17% the company's ROE is quite impressive. Probably as a result of this, Wesfarmers was able to see a decent net income growth of 9.2% over the last five years.
As a next step, we compared Wesfarmers' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 16% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for WES? You can find out in our latest intrinsic value infographic research report.
Is Wesfarmers Efficiently Re-investing Its Profits?
While Wesfarmers has a three-year median payout ratio of 87% (which means it retains 13% 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.
Additionally, Wesfarmers has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 87% of its profits over the next three years. Accordingly, forecasts suggest that Wesfarmers' future ROE will be 33% which is again, similar to the current ROE.
Summary
Overall, we feel that Wesfarmers certainly does have some positive factors to consider. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
