Most readers would already be aware that GrainCorp's (ASX:GNC) stock increased significantly by 11% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study GrainCorp's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 GrainCorp is:
12% = AU$139m ÷ AU$1.2b (Based on the trailing twelve months to September 2021).
The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.12.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
GrainCorp's Earnings Growth And 12% ROE
To begin with, GrainCorp seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 19%. Moreover, GrainCorp's net income shrunk at a rate of 20%over the past five years. Not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. Therefore, the shrinking earnings could be the result of other factors. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
As a next step, we compared GrainCorp's performance with the industry and found thatGrainCorp's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 3.8% in the same period, which is a slower than the company.
ASX:GNC Past Earnings Growth November 13th 2021
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is GNC fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is GrainCorp Efficiently Re-investing Its Profits?
Despite having a normal three-year median payout ratio of 49% (where it is retaining 51% of its profits), GrainCorp has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Additionally, GrainCorp has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 60% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 5.9%, over the same period.
Summary
Overall, we feel that GrainCorp certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. Additionally, the latest industry analyst forecasts show that the company is expected to continue to see a similar decline in its earnings in the future as well. To know more about the company's future earnings growth forecasts take a look at this freereport on analyst forecasts for the company to find out more.
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.
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