JD Sports Fashion Plc's (LON:JD.) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 13% over the past month, it is easy to disregard JD Sports Fashion (LON:JD.). 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. In this article, we decided to focus on JD Sports Fashion's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for JD Sports Fashion

How Do You 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 JD Sports Fashion is:

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

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.14 in profit.

Why Is ROE Important For Earnings Growth?

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

At first glance, JD Sports Fashion seems to have a decent ROE. On comparing with the average industry ROE of 8.0% the company's ROE looks pretty remarkable. This probably laid the ground for JD Sports Fashion's moderate 9.6% net income growth seen over the past five years.

As a next step, we compared JD Sports Fashion's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 10% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Efficiently Re-investing Its Profits?

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.

Besides, JD Sports Fashion has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 6.2% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 20%, over the same period.

Conclusion

On the whole, we feel that JD Sports Fashion's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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.