Most readers would already be aware that Big Yellow Group’s (LON:BYG) stock increased significantly by 5.2% over the past month. However, we wonder if the company’s inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Big Yellow 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. Put another way, it reveals the company’s success at turning shareholder investments into profits.
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 Big Yellow Group is:
8.0% = UK£93m ÷ UK£1.2b (Based on the trailing twelve months to March 2020).
The ‘return’ is the yearly profit. That means that for every £1 worth of shareholders’ equity, the company generated £0.08 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. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
A Side By Side comparison of Big Yellow Group’s Earnings Growth And 8.0% ROE
On the face of it, Big Yellow Group’s ROE is not much to talk about. However, the fact that the company’s ROE is higher than the average industry ROE of 4.4%, is definitely interesting. Still, Big Yellow Group’s net income growth of 2.9% over the past five years was mediocre at best. Remember, the company’s ROE is quite low to begin with, just that it is higher than the industry average. Hence, this goes some way in explaining the low earnings growth.
Next, on comparing with the industry net income growth, we found that Big Yellow Group’s reported growth was lower than the industry growth of 5.2% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. 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 Big Yellow Group is trading on a high P/E or a low P/E, relative to its industry.
Is Big Yellow Group Efficiently Re-investing Its Profits?
Big Yellow Group has a very high three-year median payout ratio of72%, implying that it retains only 28% of its profits. However, it’s not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. So this probably explains the low earnings growth seen by the company.
In addition, Big Yellow Group 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 70% of its profits over the next three years. As a result, Big Yellow Group’s ROE is not expected to change by much either, which we inferred from the analyst estimate of 6.6% for future ROE.
Overall, we have mixed feelings about Big Yellow Group. Primarily, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE. Bear in mind, the company reinvests a small portion of its profits, which explains the lack of growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page for the company.
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This article by Simply Wall St is general in nature. 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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