Most readers would already be aware that Greggs' (LON:GRG) stock increased significantly by 6.6% over the past month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Greggs' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To 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 Greggs is:
1.4% = UK£4.0m ÷ UK£284m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.01.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Greggs' Earnings Growth And 1.4% ROE
As you can see, Greggs' ROE looks pretty weak. Even when compared to the industry average of 9.1%, the ROE figure is pretty disappointing. As a result, Greggs' flat earnings over the past five years doesn't come as a surprise given its lower ROE.
We then compared Greggs' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.3% in the same period, which is a bit concerning.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is GRG fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Greggs Efficiently Re-investing Its Profits?
While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.
Our latest analyst data shows that the future payout ratio of the company is expected to rise to 66% over the next three years. Regardless, the future ROE for Greggs is speculated to rise to 20% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
Overall, we would be extremely cautious before making any decision on Greggs. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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