Costco Wholesale Corporation's (NASDAQ:COST) Stock Is Going Strong: Is the Market Following Fundamentals?

Costco Wholesale's (NASDAQ:COST) stock is up by a considerable 11% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Costco Wholesale's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Costco Wholesale

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Costco Wholesale is:

31% = US$7.4b ÷ US$24b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.31 in profit.

Why Is ROE Important For 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.

Costco Wholesale's Earnings Growth And 31% ROE

First thing first, we like that Costco Wholesale has an impressive ROE. Secondly, even when compared to the industry average of 15% the company's ROE is quite impressive. Probably as a result of this, Costco Wholesale was able to see a decent net income growth of 14% over the last five years.

We then performed a comparison between Costco Wholesale's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 14% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 COST? You can find out in our latest intrinsic value infographic research report.

Is Costco Wholesale Making Efficient Use Of Its Profits?

Costco Wholesale has a healthy combination of a moderate three-year median payout ratio of 26% (or a retention ratio of 74%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Additionally, Costco Wholesale has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. 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 22%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 26%.

Summary

Overall, we are quite pleased with Costco Wholesale's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable 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.