Marshalls plc's (LON:MSLH) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Marshalls' (LON:MSLH) stock is up by a considerable 9.9% over the past week. 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. Particularly, we will be paying attention to Marshalls' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Marshalls

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Marshalls is:

16% = UK£55m ÷ UK£344m (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.16 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Marshalls' Earnings Growth And 16% ROE

To start with, Marshalls' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 9.0%. Needless to say, we are quite surprised to see that Marshalls' net income shrunk at a rate of 4.5% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared Marshalls' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 19% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is MSLH worth today? The intrinsic value infographic in our free research report helps visualize whether MSLH is currently mispriced by the market.

Is Marshalls Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 41% (where it is retaining 59% of its profits), Marshalls has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Marshalls has been paying dividends for at least ten years or more 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 50% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Summary

On the whole, we do feel that Marshalls has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.