Grendene S.A.'s (BVMF:GRND3) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Grendene's (BVMF:GRND3) stock is up by a considerable 8.2% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Specifically, we decided to study Grendene's ROE in this article.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Grendene

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 Grendene is:

12% = R$448m ÷ R$3.6b (Based on the trailing twelve months to March 2020).

The 'return' is the income the business earned over the last year. That means that for every R$1 worth of shareholders' equity, the company generated R$0.12 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. 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 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 Grendene's Earnings Growth And 12% ROE

It is quite clear that Grendene's ROE is rather low. An industry comparison shows that the company's ROE is not much different from the industry average of 12% either. Grendene's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

We then compared Grendene's net income growth with the industry and found that the average industry growth rate was 12% in the same period.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Grendene's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Grendene Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 55% (meaning, the company retains only 45% of profits) for Grendene suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

Conclusion

On the whole, Grendene's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Grendene's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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