It is hard to get excited after looking at Myer Holdings' (ASX:MYR) recent performance, when its stock has declined 15% over the past month. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Myer Holdings' ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Myer Holdings is:
14% = AU$36m ÷ AU$264m (Based on the trailing twelve months to January 2022).
The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.14 in profit.
What Has ROE Got To Do With 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.
Myer Holdings' Earnings Growth And 14% ROE
To start with, Myer Holdings' ROE looks acceptable. Even so, when compared with the average industry ROE of 20%, we aren't very excited. Still, we can see that Myer Holdings has seen a remarkable net income growth of 26% over the past five years. Therefore, there could be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this certainly also provides some context to the high earnings growth seen by the company.
Given that the industry shrunk its earnings at a rate of 1.2% in the same period, the net income growth of the company is quite impressive.
Earnings growth is a huge factor in stock valuation. 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 Myer Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is Myer Holdings Using Its Retained Earnings Effectively?
Myer Holdings' three-year median payout ratio to shareholders is 25%, which is quite low. This implies that the company is retaining 75% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Moreover, Myer Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 64% over the next three years. However, Myer Holdings' future ROE is expected to rise to 17% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.
In total, we are pretty happy with Myer Holdings' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.