Will Weakness in Granite Construction Incorporated's (NYSE:GVA) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at Granite Construction's (NYSE:GVA) recent performance, when its stock has declined 9.0% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Granite Construction'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Granite Construction

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Granite Construction is:

11% = US$115m ÷ US$1.1b (Based on the trailing twelve months to September 2024).

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 $0.11.

What Has ROE Got To Do With 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.

Granite Construction's Earnings Growth And 11% ROE

To begin with, Granite Construction seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 18%. That being the case, the significant five-year 49% net income growth reported by Granite Construction comes as a pleasant surprise. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the high earnings growth seen by the company.

We then compared Granite Construction's 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 15% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is GVA fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Granite Construction Using Its Retained Earnings Effectively?

Granite Construction has a three-year median payout ratio of 49% (where it is retaining 51% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Granite Construction is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Granite Construction 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 8.3% over the next three years.

Summary

On the whole, we feel that Granite Construction's performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.

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

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.