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

Coles Group (ASX:COL) has had a rough month with its share price down 6.3%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Coles Group's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

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How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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

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

29% = AU$1.1b ÷ AU$3.8b (Based on the trailing twelve months to January 2025).

The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.29.

View our latest analysis for Coles Group

What Has ROE Got To Do With Earnings Growth?

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

A Side By Side comparison of Coles Group's Earnings Growth And 29% ROE

First thing first, we like that Coles Group has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 17% which is quite remarkable. Despite this, Coles Group's five year net income growth was quite flat over the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Coles Group'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 6.2% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for COL? You can find out in our latest intrinsic value infographic research report.

Is Coles Group Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 81% (implying that the company keeps only 19% of its income) of its business to reinvest into its business), most of Coles Group's profits are being paid to shareholders, which explains the absence of growth in earnings.

Additionally, Coles Group has paid dividends over a period of six 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 83%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 32%.

Summary

In total, it does look like Coles Group has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. 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. 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.