Is Greggs plc's (LON:GRG) Latest Stock Performance Being Led By Its Strong Fundamentals?

Greggs' (LON:GRG) stock up by 4.5% over the past three months. Since the market usually pay for a company’s long-term financial health, we decided to study the company’s fundamentals to see if they could be influencing the market. Specifically, we decided to study Greggs' ROE in this article.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Greggs

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 Greggs is:

29% = UK£135m ÷ UK£461m (Based on the trailing twelve months to July 2023).

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.29 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. 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.

A Side By Side comparison of Greggs' Earnings Growth And 29% ROE

Firstly, we acknowledge that Greggs has a significantly high ROE. Secondly, even when compared to the industry average of 8.0% the company's ROE is quite impressive. This likely paved the way for the modest 20% net income growth seen by Greggs over the past five years.

Next, on comparing with the industry net income growth, we found that Greggs' growth is quite high when compared to the industry average growth of 1.3% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Greggs is trading on a high P/E or a low P/E, relative to its industry.

Is Greggs Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 47% (implying that the company retains 53% of its profits), it seems that Greggs is reinvesting efficiently in a way that it sees respectable amount growth in its earnings 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. 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 51%. Accordingly, forecasts suggest that Greggs' future ROE will be 27% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with Greggs' performance. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.