Is Brambles Limited's (ASX:BXB) Latest Stock Performance Being Led By Its Strong Fundamentals?

Brambles' (ASX:BXB) stock is up by 8.2% over the past three months. 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 Brambles' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Brambles

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 Brambles is:

23% = US$600m ÷ US$2.6b (Based on the trailing twelve months to December 2022).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.23 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Brambles' Earnings Growth And 23% ROE

Firstly, we acknowledge that Brambles has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 4.8% also doesn't go unnoticed by us. However, we are curious as to how the high returns still resulted in a flat growth for Brambles in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital

Next, on comparing with the industry net income growth, we found that Brambles' growth figure is a bit better than the industry which has been shrinking at a rate of 1.2% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 BXB? You can find out in our latest intrinsic value infographic research report.

Is Brambles Efficiently Re-investing Its Profits?

Brambles has a high three-year median payout ratio of 56% (or a retention ratio of 44%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Additionally, Brambles 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 56%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 24%.

Summary

In total, we are pretty happy with Brambles' 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. 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. 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.