PVH (NYSE:PVH) has had a great run on the share market with its stock up by a significant 41% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study PVH's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
Return on equity 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 PVH is:
9.4% = US$453m ÷ US$4.8b (Based on the trailing twelve months to October 2022).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.09 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. 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.
PVH's Earnings Growth And 9.4% ROE
When you first look at it, PVH's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 21%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 6.8% seen by PVH over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.
So, as a next step, we compared PVH's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 14% in the same 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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for PVH? You can find out in our latest intrinsic value infographic research report.
Is PVH Efficiently Re-investing Its Profits?
PVH's low LTM (or last twelve month) payout ratio of 1.7% (implying that it retains the remaining 98% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, PVH has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 1.4% of its profits over the next three years. Still, forecasts suggest that PVH's future ROE will rise to 13% even though the the company's payout ratio is not expected to change by much.
On the whole, we feel that the performance shown by PVH can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
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