Declining Stock and Solid Fundamentals: Is The Market Wrong About W.W. Grainger, Inc. (NYSE:GWW)?

With its stock down 15% over the past three months, it is easy to disregard W.W. Grainger (NYSE:GWW). 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 W.W. Grainger's ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for W.W. Grainger

How Do You Calculate Return On Equity?

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 W.W. Grainger is:

54% = US$2.0b ÷ US$3.7b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.54 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

W.W. Grainger's Earnings Growth And 54% ROE

Firstly, we acknowledge that W.W. Grainger has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 17% also doesn't go unnoticed by us. So, the substantial 23% net income growth seen by W.W. Grainger over the past five years isn't overly surprising.

Next, on comparing W.W. Grainger's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 23% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is W.W. Grainger fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is W.W. Grainger Using Its Retained Earnings Effectively?

W.W. Grainger has a really low three-year median payout ratio of 21%, meaning that it has the remaining 79% left over to reinvest into its business. So it looks like W.W. Grainger is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, W.W. Grainger 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 21% of its profits over the next three years. Regardless, W.W. Grainger's ROE is speculated to decline to 41% despite there being no anticipated change in its payout ratio.

Summary

Overall, we are quite pleased with W.W. Grainger'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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.