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It is hard to get excited after looking at Ross Stores' (NASDAQ:ROST) recent performance, when its stock has declined 2.9% over the past week. 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 Ross Stores' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Ross Stores
How To 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 Ross Stores is:
40% = US$2.1b ÷ US$5.3b (Based on the trailing twelve months to November 2024).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.40 in profit.
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. 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.
Ross Stores' Earnings Growth And 40% ROE
To begin with, Ross Stores has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 19% which is quite remarkable. This probably laid the groundwork for Ross Stores' moderate 17% net income growth seen over the past five years.
We then performed a comparison between Ross Stores' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 17% in the same 5-year period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is ROST fairly valued? This infographic on the company's intrinsic value has everything you need to know.