Brisbane Broncos Limited's (ASX:BBL) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Brisbane Broncos (ASX:BBL) has had a great run on the share market with its stock up by a significant 13% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Brisbane Broncos' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Brisbane Broncos

How Is ROE Calculated?

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 Brisbane Broncos is:

3.8% = AU$1.4m ÷ AU$36m (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$0.04 in profit.

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Brisbane Broncos' Earnings Growth And 3.8% ROE

It is quite clear that Brisbane Broncos' ROE is rather low. Not just that, even compared to the industry average of 12%, the company's ROE is entirely unremarkable. For this reason, Brisbane Broncos' five year net income decline of 7.5% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

With the industry earnings declining at a rate of 7.5% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Brisbane Broncos''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Brisbane Broncos Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 43% (or a retention ratio of 57%) which is pretty normal, Brisbane Broncos' declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Brisbane Broncos has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

In total, we're a bit ambivalent about Brisbane Broncos' performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 2 risks we have identified for Brisbane Broncos visit our risks dashboard for free.

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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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