Are Poor Financial Prospects Dragging Down Gooch & Housego PLC (LON:GHH Stock?

Gooch & Housego (LON:GHH) has had a rough month with its share price down 17%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Gooch & Housego'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.

View our latest analysis for Gooch & Housego

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Gooch & Housego is:

3.4% = UK£4.0m ÷ UK£120m (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.03.

What Is The Relationship Between ROE And 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. 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 Gooch & Housego's Earnings Growth And 3.4% ROE

It is hard to argue that Gooch & Housego's ROE is much good in and of itself. Even when compared to the industry average of 10%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 27% seen by Gooch & Housego over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Gooch & Housego's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.5% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. 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 GHH fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Gooch & Housego Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 66% (implying that 34% of the profits are retained), most of Gooch & Housego's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 2 risks we have identified for Gooch & Housego by visiting our risks dashboard for free on our platform here.

Additionally, Gooch & Housego has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 27% over the next three years. The fact that the company's ROE is expected to rise to 8.3% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, Gooch & Housego's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.