Are Pernod Ricard SA's (EPA:RI) Mixed Financials Driving The Negative Sentiment?

Pernod Ricard (EPA:RI) has had a rough three months with its share price down 23%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Pernod Ricard'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Pernod Ricard

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 Pernod Ricard is:

9.0% = €1.5b ÷ €17b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.09 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Pernod Ricard's Earnings Growth And 9.0% ROE

When you first look at it, Pernod Ricard's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.2%. Having said that, Pernod Ricard has shown a modest net income growth of 18% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Pernod Ricard'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 27% in the same period.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Pernod Ricard is trading on a high P/E or a low P/E, relative to its industry.

Is Pernod Ricard Using Its Retained Earnings Effectively?

Pernod Ricard has a significant three-year median payout ratio of 53%, meaning that it is left with only 47% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Pernod Ricard 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 58%. Still, forecasts suggest that Pernod Ricard's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we have mixed feelings about Pernod Ricard. While no doubt its earnings growth is pretty respectable, the low profit retention could mean that the company's earnings growth could have been higher, had it been paying reinvesting a higher portion of its profits. An improvement in its ROE could also help future earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.