Barratt Developments (LON:BDEV) has had a great run on the share market with its stock up by a significant 15% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Barratt Developments' ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You 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 Barratt Developments is:
7.8% = UK£406m ÷ UK£5.2b (Based on the trailing twelve months to December 2020).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.08 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 Barratt Developments' Earnings Growth And 7.8% ROE
At first glance, Barratt Developments' ROE doesn't look very promising. However, the fact that the company's ROE is higher than the average industry ROE of 5.4%, is definitely interesting. Still, Barratt Developments has seen a flat net income growth over the past five years. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to stay flat.
From the 0.5% decline reported by the industry in the same period, we infer that Barratt Developments and its industry are both shrinking at a similar rate.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Barratt Developments''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Barratt Developments Making Efficient Use Of Its Profits?
Despite having a moderate three-year median payout ratio of 39% (meaning the company retains61% of profits) in the last three-year period, Barratt Developments' earnings growth was more or les flat. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Moreover, Barratt Developments has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 59% over the next three years. Regardless, the future ROE for Barratt Developments is speculated to rise to 13% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
On the whole, we do feel that Barratt Developments has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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. 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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