Stock Analysis

Do Its Financials Have Any Role To Play In Driving GWA Group Limited's (ASX:GWA) Stock Up Recently?

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Most readers would already be aware that GWA Group's (ASX:GWA) stock increased significantly by 16% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on GWA Group's ROE.

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.

See our latest analysis for GWA Group

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for GWA Group is:

16% = AU\$44m ÷ AU\$280m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. 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?

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.

GWA Group's Earnings Growth And 16% ROE

To start with, GWA Group's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 9.0%. Despite this, GWA Group's five year net income growth was quite low averaging at only 4.4%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then performed a comparison between GWA Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 5.3% in the same period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about GWA Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is GWA Group Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 96% (or a retention ratio of 3.9%), most of GWA Group's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Additionally, GWA Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 72% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

In total, it does look like GWA Group has some positive aspects to its business. The company has grown its earnings moderately as a result of its impressive ROE. Yet, the business is retaining hardly any of its profits. This might have negative implications on the company's future growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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