With its stock down 9.5% over the past three months, it is easy to disregard Woolworths Holdings (JSE:WHL). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Woolworths Holdings' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Woolworths Holdings
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 Woolworths Holdings is:
32% = R3.9b ÷ R12b (Based on the trailing twelve months to June 2023).
The 'return' refers to a company's earnings over the last year. So, this means that for every ZAR1 of its shareholder's investments, the company generates a profit of ZAR0.32.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
A Side By Side comparison of Woolworths Holdings' Earnings Growth And 32% ROE
To begin with, Woolworths Holdings has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 8.3% the company's ROE is quite impressive. As a result, Woolworths Holdings' exceptional 50% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing with the industry net income growth, we found that Woolworths Holdings' growth is quite high when compared to the industry average growth of 5.8% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Woolworths Holdings is trading on a high P/E or a low P/E, relative to its industry.