Greggs plc's (LON:GRG) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 13% over the past three months, it is easy to disregard Greggs (LON:GRG). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Greggs' 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.

Check out our latest analysis for Greggs

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 Greggs is:

28% = UK£137m ÷ UK£494m (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.28.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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 Greggs' Earnings Growth And 28% ROE

First thing first, we like that Greggs has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 8.4% which is quite remarkable. Under the circumstances, Greggs' considerable five year net income growth of 25% was to be expected.

We then performed a comparison between Greggs' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 21% in the same 5-year period.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Greggs''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Greggs Making Efficient Use Of Its Profits?

Greggs' three-year median payout ratio is a pretty moderate 47%, meaning the company retains 53% of its income. So it seems that Greggs is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, Greggs has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 50%. As a result, Greggs' ROE is not expected to change by much either, which we inferred from the analyst estimate of 24% for future ROE.

Conclusion

On the whole, we feel that Greggs' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.