Is Reece Limited's (ASX:REH) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

Most readers would already be aware that Reece's (ASX:REH) stock increased significantly by 12% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Reece's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Reece

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 Reece is:

8.3% = AU$229m ÷ AU$2.7b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.08 in profit.

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.

Reece's Earnings Growth And 8.3% ROE

When you first look at it, Reece's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 5.2%, is definitely interesting. However, Reece's five year net income growth was quite low averaging at only 5.0%. 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.

As a next step, we compared Reece's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 37% 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. If you're wondering about Reece's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Reece Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 47% (or a retention ratio of 53% over the past three years, Reece has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Reece 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 41% of its profits over the next three years. As a result, Reece's ROE is not expected to change by much either, which we inferred from the analyst estimate of 8.4% for future ROE.

Summary

In total, it does look like Reece has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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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