Genuine Parts' (NYSE:GPC) stock is up by 4.3% over the past week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Genuine Parts' ROE today.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Genuine Parts is:
26% = US$899m ÷ US$3.5b (Based on the trailing twelve months to December 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.26 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.
A Side By Side comparison of Genuine Parts' Earnings Growth And 26% ROE
Firstly, we acknowledge that Genuine Parts has a significantly high ROE. Secondly, even when compared to the industry average of 19% the company's ROE is quite impressive. Needless to say, we are quite surprised to see that Genuine Parts' net income shrunk at a rate of 6.1% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.
That being said, we compared Genuine Parts' 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 15% in the same period.
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). Doing so will help them establish if the stock's future looks promising or ominous. What is GPC worth today? The intrinsic value infographic in our free research report helps visualize whether GPC is currently mispriced by the market.
Is Genuine Parts Using Its Retained Earnings Effectively?
Genuine Parts' 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 58% (or a retention ratio of 42%). 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, Genuine Parts 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. 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 48%. As a result, Genuine Parts' ROE is not expected to change by much either, which we inferred from the analyst estimate of 26% for future ROE.
In total, it does look like Genuine Parts has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.
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.