Goodman Group's (ASX:GMG) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Goodman Group (ASX:GMG) has had a rough week with its share price down 2.8%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Goodman Group's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Goodman 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 Goodman Group is:

13% = AU$1.5b ÷ AU$12b (Based on the trailing twelve months to June 2020).

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$0.13.

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. 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 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.

Goodman Group's Earnings Growth And 13% ROE

To begin with, Goodman Group seems to have a respectable ROE. On comparing with the average industry ROE of 6.6% the company's ROE looks pretty remarkable. This certainly adds some context to Goodman Group's decent 5.3% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Goodman Group's reported growth was lower than the industry growth of 8.5% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is GMG worth today? The intrinsic value infographic in our free research report helps visualize whether GMG is currently mispriced by the market.

Is Goodman Group Making Efficient Use Of Its Profits?

Goodman Group seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 58%, meaning the company retains only 42% of its income. However, this is typical for REITs as they are often required by law to distribute most of their earnings. In spite of this, the company was able to grow its earnings by a fair bit, as we saw above.

Moreover, Goodman Group is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 46% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Summary

In total, it does look like Goodman Group has some positive aspects to its business. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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