Declining Stock and Decent Financials: Is The Market Wrong About Best Buy Co., Inc. (NYSE:BBY)?

Best Buy (NYSE:BBY) has had a rough week with its share price down 6.8%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Best Buy's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Best Buy

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 Best Buy is:

40% = US$1.2b ÷ US$3.1b (Based on the trailing twelve months to May 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.40.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Best Buy's Earnings Growth And 40% ROE

To begin with, Best Buy has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 19% the company's ROE is quite impressive. As you might expect, the 3.6% net income decline reported by Best Buy doesn't bode well with us. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

That being said, we compared Best Buy's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 23% 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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for BBY? You can find out in our latest intrinsic value infographic research report.

Is Best Buy Making Efficient Use Of Its Profits?

Best Buy's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 54% (or a retention ratio of 46%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run.

Moreover, Best Buy 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 50%. Accordingly, forecasts suggest that Best Buy's future ROE will be 43% which is again, similar to the current ROE.

Summary

Overall, we feel that Best Buy certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.

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