Are Poor Financial Prospects Dragging Down Barratt Redrow plc (LON:BTRW Stock?

With its stock down 13% over the past three months, it is easy to disregard Barratt Redrow (LON:BTRW). 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 Barratt Redrow's ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Barratt Redrow

How Is ROE Calculated?

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 Redrow is:

2.1% = UK£114m ÷ UK£5.4b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Barratt Redrow's Earnings Growth And 2.1% ROE

It is hard to argue that Barratt Redrow's ROE is much good in and of itself. Even when compared to the industry average of 6.0%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 16% seen by Barratt Redrow was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 0.4% over the last few years, we found that Barratt Redrow's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for BTRW? You can find out in our latest intrinsic value infographic research report.

Is Barratt Redrow Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 67% (implying that 33% of the profits are retained), most of Barratt Redrow's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 4 risks we have identified for Barratt Redrow by visiting our risks dashboard for free on our platform here.

Additionally, Barratt Redrow has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 59%. Regardless, the future ROE for Barratt Redrow is predicted to rise to 7.6% despite there being not much change expected in its payout ratio.

Summary

In total, we would have a hard think before deciding on any investment action concerning Barratt Redrow. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. 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. 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.