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

GMS (NYSE:GMS) has had a rough month with its share price down 15%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to GMS' ROE today.

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 GMS

How To 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 GMS is:

15% = US$219m ÷ US$1.5b (Based on the trailing twelve months to October 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.15 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

GMS' Earnings Growth And 15% ROE

To begin with, GMS seems to have a respectable ROE. Even when compared to the industry average of 17% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 31% seen over the past five years by GMS. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared GMS' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 23% in the same 5-year period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for GMS? You can find out in our latest intrinsic value infographic research report.

Is GMS Efficiently Re-investing Its Profits?

GMS doesn't pay any regular dividends to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.

Conclusion

Overall, we are quite pleased with GMS' 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. 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.