Is Grainger plc's (LON:GRI) Stock's Recent Performance A Reflection Of Its Financial Health?

Grainger's (LON:GRI) stock up by 8.3% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Grainger's 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Grainger

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

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

8.2% = UK£159m ÷ UK£1.9b (Based on the trailing twelve months to March 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.08 in profit.

What Is The Relationship Between ROE And 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.

Grainger's Earnings Growth And 8.2% ROE

When you first look at it, Grainger's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 6.8% doesn't go unnoticed by us. This certainly adds some context to Grainger's moderate 17% net income growth seen over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So there might well be other reasons for the earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.

We then compared Grainger's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 13% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Grainger fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Grainger Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 31% (implying that the company retains 69% of its profits), it seems that Grainger is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Grainger has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 77% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 2.8% over the same period.

Conclusion

On the whole, we feel that Grainger's performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.