It is hard to get excited after looking at Bapcor's (ASX:BAP) recent performance, when its stock has declined 11% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Bapcor's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Bapcor is:
8.0% = AU$79m ÷ AU$982m (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.08 in profit.
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 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.
Bapcor's Earnings Growth And 8.0% ROE
When you first look at it, Bapcor's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 6.4%, is definitely interesting. Especially when you consider Bapcor's exceptional 24% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So, there might well be other reasons for the earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.
Next, on comparing with the industry net income growth, we found that Bapcor's growth is quite high when compared to the industry average growth of 14% in the same period, which is great 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). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for BAP? You can find out in our latest intrinsic value infographic research report.
Is Bapcor Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 51% (implying that it keeps only 49% of profits) for Bapcor suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Besides, Bapcor has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 54%. However, Bapcor's ROE is predicted to rise to 12% despite there being no anticipated change in its payout ratio.
In total, it does look like Bapcor has some positive aspects to its business. Namely, its significant earnings growth, to which its moderate rate of return likely contributed. 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, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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. 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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