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It is hard to get excited after looking at Balfour Beatty's (LON:BBY) recent performance, when its stock has declined 5.5% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Balfour Beatty's ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Balfour Beatty
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 Balfour Beatty is:
10% = UK£139m ÷ UK£1.4b (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.10 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. 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. 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.
Balfour Beatty's Earnings Growth And 10% ROE
At first glance, Balfour Beatty seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 9.1%. However, we are curious as to how Balfour Beatty's decent returns still resulted in flat growth for Balfour Beatty in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.
When you consider the fact that the industry earnings have shrunk at a rate of 2.7% in the same period, the company's net income growth is pretty remarkable.
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 Balfour Beatty's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.