Most readers would already be aware that UniFirst's (NYSE:UNF) stock increased significantly by 13% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study UniFirst'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Our analysis indicates that UNF is potentially undervalued!
How Do You 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 UniFirst is:
5.4% = US$103m ÷ US$1.9b (Based on the trailing twelve months to August 2022).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.05 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. 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.
UniFirst's Earnings Growth And 5.4% ROE
On the face of it, UniFirst's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 12%. Therefore, UniFirst's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
As a next step, we compared UniFirst's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 2.7% in the same period.
Earnings growth is a huge factor in stock valuation. 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 UNF fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is UniFirst Using Its Retained Earnings Effectively?
UniFirst has a low three-year median payout ratio of 14% (or a retention ratio of 86%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.
Moreover, UniFirst has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 15% of its profits over the next three years. However, UniFirst's ROE is predicted to rise to 7.2% despite there being no anticipated change in its payout ratio.
Overall, we have mixed feelings about UniFirst. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
What are the risks and opportunities for UniFirst?
Trading at 36.2% below our estimate of its fair value
Earnings are forecast to grow 24.44% per year
Profit margins (5%) are lower than last year (7.7%)
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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.