Baby Bunting Group Limited's (ASX:BBN) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Baby Bunting Group's (ASX:BBN) recent performance, when its stock has declined 14% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Baby Bunting Group'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.

View our latest analysis for Baby Bunting Group

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Baby Bunting Group is:

17% = AU$20m ÷ AU$115m (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.17 in profit.

What Is The Relationship Between ROE And 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. 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.

Baby Bunting Group's Earnings Growth And 17% ROE

To start with, Baby Bunting Group's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 21%. Consequently, this likely laid the ground for the decent growth of 14% seen over the past five years by Baby Bunting Group.

We then compared Baby Bunting Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 21% in the same period, which is a bit concerning.

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. What is BBN worth today? The intrinsic value infographic in our free research report helps visualize whether BBN is currently mispriced by the market.

Is Baby Bunting Group Using Its Retained Earnings Effectively?

Baby Bunting Group has a very high three-year median payout ratio of 106% suggesting that the company's shareholders are getting paid from more than just the company's earnings. However, this hasn't really hampered its ability to grow as we saw earlier. That being said, the high payout ratio could be worth keeping an eye on in case the company is unable to keep up its current growth momentum. You can see the 3 risks we have identified for Baby Bunting Group by visiting our risks dashboard for free on our platform here.

Additionally, Baby Bunting Group has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 70% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 31%, over the same period.

Conclusion

Overall, we feel that Baby Bunting Group certainly does have some positive factors to consider. Its earnings have grown respectably as we saw earlier, probably due to its high returns. However, it does reinvest little to almost none of its profits, so we wonder what effect this could have on its future growth prospects. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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