Declining Stock and Solid Fundamentals: Is The Market Wrong About JB Hi-Fi Limited (ASX:JBH)?

Simply Wall St

Sun, Dec 5, 2021, 6:39 PM 4 min read

It is hard to get excited after looking at JB Hi-Fi's (ASX:JBH) recent performance, when its stock has declined 5.4% 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. Specifically, we decided to study JB Hi-Fi's ROE in this article.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for JB Hi-Fi

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for JB Hi-Fi is:

39% = AU$506m ÷ AU$1.3b (Based on the trailing twelve months to June 2021).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.39 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of JB Hi-Fi's Earnings Growth And 39% ROE

To begin with, JB Hi-Fi has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 24% also doesn't go unnoticed by us. Under the circumstances, JB Hi-Fi's considerable five year net income growth of 23% was to be expected.

We then compared JB Hi-Fi's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% in the same period.

past-earnings-growth — ASX:JBH Past Earnings Growth December 6th 2021

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is JBH worth today? The intrinsic value infographic in our free research report helps visualize whether JBH is currently mispriced by the market.

Is JB Hi-Fi Using Its Retained Earnings Effectively?

JB Hi-Fi has a significant three-year median payout ratio of 66%, meaning the company only retains 34% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Additionally, JB Hi-Fi 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 65%. Regardless, JB Hi-Fi's ROE is speculated to decline to 24% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with JB Hi-Fi's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.