Most readers would already be aware that Richelieu Hardware's (TSE:RCH) stock increased significantly by 6.7% over the past week. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Richelieu Hardware's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Richelieu Hardware is:
19% = CA$115m ÷ CA$592m (Based on the trailing twelve months to May 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.19 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Richelieu Hardware's Earnings Growth And 19% ROE
At first glance, Richelieu Hardware seems to have a decent ROE. Even when compared to the industry average of 19% the company's ROE looks quite decent. This probably goes some way in explaining Richelieu Hardware's moderate 8.1% growth over the past five years amongst other factors.
As a next step, we compared Richelieu Hardware'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 16% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. What is RCH worth today? The intrinsic value infographic in our free research report helps visualize whether RCH is currently mispriced by the market.
Is Richelieu Hardware Making Efficient Use Of Its Profits?
In Richelieu Hardware's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 20% (or a retention ratio of 80%), which suggests that the company is investing most of its profits to grow its business.
Additionally, Richelieu Hardware has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 16% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
On the whole, we feel that Richelieu Hardware's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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 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.
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