Is Reece Limited's(ASX:REH) Recent Stock Performance Tethered To Its Strong Fundamentals?

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Simply Wall St

Wed, Jan 5, 2022, 8:00 PM 4 min read

Reece's (ASX:REH) stock is up by a considerable 56% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Reece'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.

See our latest analysis for Reece

How Do You Calculate Return On Equity?

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 Reece is:

9.9% = AU$286m ÷ AU$2.9b (Based on the trailing twelve months to June 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$0.10.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Reece's Earnings Growth And 9.9% ROE

To start with, Reece's ROE looks acceptable. Even when compared to the industry average of 8.2% the company's ROE looks quite decent. This probably goes some way in explaining Reece's moderate 5.5% growth over the past five years amongst other factors.

As a next step, we compared Reece's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 27% in the same period.

past-earnings-growth — ASX:REH Past Earnings Growth January 6th 2022

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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Reece is trading on a high P/E or a low P/E, relative to its industry.

Is Reece Using Its Retained Earnings Effectively?

Reece has a three-year median payout ratio of 45%, which implies that it retains the remaining 55% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Reece 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 42%. Regardless, the future ROE for Reece is predicted to rise to 12% despite there being not much change expected in its payout ratio.

Summary

Overall, we are quite pleased with Reece's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.