GUD Holdings Limited (ASX:GUD) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

With its stock down 13% over the past week, it is easy to disregard GUD Holdings (ASX:GUD). 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 GUD Holdings' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for GUD Holdings

How Do You 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 GUD Holdings is:

16% = AU$61m ÷ AU$389m (Based on the trailing twelve months to June 2021).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.16.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of GUD Holdings' Earnings Growth And 16% ROE

To start with, GUD Holdings' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 19%. GUD Holdings' decent returns aren't reflected in GUD Holdings'mediocre five year net income growth average of 3.9%. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that GUD Holdings' reported growth was lower than the industry growth of 23% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for GUD? You can find out in our latest intrinsic value infographic research report.

Is GUD Holdings Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 83% (or a retention ratio of 17%), most of GUD Holdings' profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, GUD Holdings has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 69%. As a result, GUD Holdings' ROE is not expected to change by much either, which we inferred from the analyst estimate of 18% for future ROE.

Summary

On the whole, we do feel that GUD Holdings has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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.