Grainger plc's (LON:GRI) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

By
Simply Wall St
Published
February 18, 2022
LSE:GRI
Source: Shutterstock

Grainger (LON:GRI) has had a rough three months with its share price down 8.0%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Grainger's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Grainger

How To Calculate Return On Equity?

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 Grainger is:

6.3% = UK£110m ÷ UK£1.7b (Based on the trailing twelve months to September 2021).

The 'return' refers to a company's earnings over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Grainger's Earnings Growth And 6.3% ROE

At first glance, Grainger's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 12%. Although, we can see that Grainger saw a modest net income growth of 6.7% over the past five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Grainger compares quite favourably to the industry average, which shows a decline of 3.5% in the same period.

past-earnings-growth
LSE:GRI Past Earnings Growth February 18th 2022

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

Is Grainger Making Efficient Use Of Its Profits?

Grainger has a healthy combination of a moderate three-year median payout ratio of 32% (or a retention ratio of 68%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Grainger has been paying dividends for at least ten years or more. 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's future payout ratio is expected to rise to 65% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 3.8%) over the same period.

Conclusion

On the whole, we do feel that Grainger has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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