Weak Financial Prospects Seem To Be Dragging Down Bapcor Limited (ASX:BAP) Stock

It is hard to get excited after looking at Bapcor's (ASX:BAP) recent performance, when its stock has declined 26% over the past three months. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on Bapcor's ROE.

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.

See our latest analysis for Bapcor

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 Bapcor is:

8.7% = AU$98m ÷ AU$1.1b (Based on the trailing twelve months to December 2023).

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$0.09.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of Bapcor's Earnings Growth And 8.7% ROE

When you first look at it, Bapcor's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 8.1%, so we won't completely dismiss the company. On the other hand, Bapcor reported a fairly low 4.9% net income growth over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

As a next step, we compared Bapcor'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 17% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 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 61% (that is, the company retains only 39% of its income) over the past three years for Bapcor suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Additionally, Bapcor has paid dividends over a period of nine years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 56% of its profits over the next three years. Accordingly, forecasts suggest that Bapcor's future ROE will be 8.3% which is again, similar to the current ROE.

Summary

On the whole, Bapcor's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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 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. 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.