Declining Stock and Solid Fundamentals: Is The Market Wrong About JD Sports Fashion Plc (LON:JD.)?

It is hard to get excited after looking at JD Sports Fashion's (LON:JD.) recent performance, when its stock has declined 36% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to JD Sports Fashion's ROE today.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for JD Sports Fashion

How Do You 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 JD Sports Fashion is:

14% = UK£400m ÷ UK£2.8b (Based on the trailing twelve months to August 2024).

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 £0.14 in profit.

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 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.

JD Sports Fashion's Earnings Growth And 14% ROE

To begin with, JD Sports Fashion seems to have a respectable ROE. On comparing with the average industry ROE of 10.0% the company's ROE looks pretty remarkable. This certainly adds some context to JD Sports Fashion's decent 9.6% net income growth seen over the past five years.

Next, on comparing JD Sports Fashion's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 10% over the last few years.

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 JD Sports Fashion's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is JD Sports Fashion Using Its Retained Earnings Effectively?

JD Sports Fashion's three-year median payout ratio to shareholders is 12% (implying that it retains 88% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, JD Sports Fashion 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 7.4% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 18%, over the same period.

Conclusion

In total, we are pretty happy with JD Sports Fashion's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.