Is Adairs Limited's (ASX:ADH) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

editorial-team@simplywallst.com (Simply Wall St)

Sun, Oct 13, 2024, 5:40 PM 4 min read

Adairs (ASX:ADH) has had a great run on the share market with its stock up by a significant 15% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Adairs' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Adairs

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 Adairs is:

14% = AU$31m ÷ AU$223m (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.14 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Adairs' Earnings Growth And 14% ROE

To begin with, Adairs seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 17%. Given the circumstances, we can't help but wonder why Adairs saw little to no growth in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then compared Adairs' net income growth with the industry and found that the average industry growth rate was 15% in the same 5-year period.

past-earnings-growth — ASX:ADH Past Earnings Growth October 13th 2024

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Adairs''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Adairs Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 64% (implying that the company keeps only 36% of its income) of its business to reinvest into its business), most of Adairs' profits are being paid to shareholders, which explains the absence of growth in earnings.

Moreover, Adairs has been paying dividends for nine years, which is a considerable amount of time, 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 63%. Still, forecasts suggest that Adairs' future ROE will rise to 19% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we do feel that Adairs has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.