GUD Holdings Limited's (ASX:GUD) Stock Is Going Strong: Is the Market Following Fundamentals?

GUD Holdings (ASX:GUD) has had a great run on the share market with its stock up by a significant 9.5% over the last week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study GUD Holdings' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for GUD Holdings

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 GUD Holdings is:

16% = AU$44m ÷ AU$275m (Based on the trailing twelve months to June 2020).

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$0.16 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. 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 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 16%. Consequently, this likely laid the ground for the decent growth of 12% seen over the past five years by GUD Holdings.

As a next step, we compared GUD Holdings' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 13% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about GUD Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is GUD Holdings Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 85% (or a retention ratio of 15%) for GUD Holdings suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, GUD Holdings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 77% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 18%.

Conclusion

In total, we are pretty happy with GUD Holdings' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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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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