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Greggs (LON:GRG) has had a rough three months with its share price down 34%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Greggs' ROE.
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.
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 Greggs is:
27% = UK£153m ÷ UK£571m (Based on the trailing twelve months to December 2024).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.27.
See our latest analysis for Greggs
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.
Greggs' Earnings Growth And 27% ROE
To begin with, Greggs has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 7.2% also doesn't go unnoticed by us. So, the substantial 28% net income growth seen by Greggs over the past five years isn't overly surprising.
We then performed a comparison between Greggs' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 28% in the same 5-year period.
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. This then helps them determine if the stock is placed for a bright or bleak future. Is Greggs fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Greggs Using Its Retained Earnings Effectively?
Greggs has a three-year median payout ratio of 47% (where it is retaining 53% of its income) which is not too low or not too high. So it seems that Greggs is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.