Sprouts Farmers Market, Inc.'s (NASDAQ:SFM) Stock Is Going Strong: Is the Market Following Fundamentals?

Most readers would already be aware that Sprouts Farmers Market's (NASDAQ:SFM) stock increased significantly by 11% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Sprouts Farmers Market's ROE in this article.

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 Sprouts Farmers Market

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 Sprouts Farmers Market is:

24% = US$249m ÷ US$1.1b (Based on the trailing twelve months to April 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.24 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. 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.

Sprouts Farmers Market's Earnings Growth And 24% ROE

To begin with, Sprouts Farmers Market has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 11% the company's ROE is quite impressive. This probably laid the groundwork for Sprouts Farmers Market's moderate 12% net income growth seen over the past five years.

Next, on comparing Sprouts Farmers Market's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 10% in the same 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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Sprouts Farmers Market is trading on a high P/E or a low P/E, relative to its industry.

Is Sprouts Farmers Market Making Efficient Use Of Its Profits?

Given that Sprouts Farmers Market doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

On the whole, we feel that Sprouts Farmers Market's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. 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.

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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.