Declining Stock and Solid Fundamentals: Is The Market Wrong About Graco Inc. (NYSE:GGG)?

It is hard to get excited after looking at Graco's (NYSE:GGG) recent performance, when its stock has declined 14% 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. Specifically, we decided to study Graco's ROE in this article.

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 Graco

How Is ROE Calculated?

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 Graco is:

21% = US$500m ÷ US$2.3b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.

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. 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 Graco's Earnings Growth And 21% ROE

To start with, Graco's ROE looks acceptable. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. This certainly adds some context to Graco's decent 11% net income growth seen over the past five years.

As a next step, we compared Graco's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.9%.

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 GGG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Graco Using Its Retained Earnings Effectively?

Graco has a three-year median payout ratio of 31%, which implies that it retains the remaining 69% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Graco is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 31%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 20%.

Conclusion

In total, we are pretty happy with Graco's performance. 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com