JD Sports Fashion Plc's (LON:JD.) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at JD Sports Fashion's (LON:JD.) recent performance, when its stock has declined 30% over the past month. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study JD Sports Fashion'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.

View our latest analysis for JD Sports Fashion

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 JD Sports Fashion is:

12% = UK£289m ÷ UK£2.5b (Based on the trailing twelve months to July 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.12.

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.

A Side By Side comparison of JD Sports Fashion's Earnings Growth And 12% ROE

To start with, JD Sports Fashion's ROE looks acceptable. Even so, when compared with the average industry ROE of 15%, we aren't very excited. On further research, we found that JD Sports Fashion's earnings over the past five years have been pretty flat. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So there might be other reasons for the flat earnings growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitve pressures.

Next, on comparing with the industry net income growth, we found that JD Sports Fashion's reported growth was lower than the industry growth of 17% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is JD Sports Fashion fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is JD Sports Fashion Efficiently Re-investing Its Profits?

JD Sports Fashion's low three-year median payout ratio of 6.2% (implying that the company keeps94% of its income) should mean that the company is retaining most of its earnings to fuel its growth and this should be reflected in its growth number, but that's not the case.

In addition, JD Sports Fashion has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 7.0% of its profits over the next three years. Regardless, the future ROE for JD Sports Fashion is predicted to rise to 21% despite there being not much change expected in its payout ratio.

Conclusion

In total, it does look like JD Sports Fashion has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering 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 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.