Is Greggs plc's (LON:GRG) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Most readers would already be aware that Greggs' (LON:GRG) stock increased significantly by 10% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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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:

27% = UK£153m ÷ UK£571m (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.27 in profit.

Check out our latest analysis for Greggs

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Greggs' Earnings Growth And 27% ROE

To begin with, Greggs has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 7.6% which is quite remarkable. So, the substantial 28% net income growth seen by Greggs over the past five years isn't overly surprising.

We then compared Greggs' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 36% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Using Its Retained Earnings Effectively?

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 over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 51% of its profits over the next three years. However, Greggs' future ROE is expected to decline to 20% despite there being not much change anticipated in the company's payout ratio.

Conclusion

On the whole, we feel that Greggs' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink 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.