Could The Market Be Wrong About Woolworths Holdings Limited (JSE:WHL) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Woolworths Holdings' (JSE:WHL) recent performance, when its stock has declined 8.1% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Woolworths Holdings' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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How Do You 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 Woolworths Holdings is:

25% = R3.0b ÷ R12b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. That means that for every ZAR1 worth of shareholders' equity, the company generated ZAR0.25 in profit.

Check out our latest analysis for Woolworths Holdings

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.

Woolworths Holdings' Earnings Growth And 25% ROE

To start with, Woolworths Holdings' ROE looks acceptable. Especially when compared to the industry average of 9.5% the company's ROE looks pretty impressive. This probably laid the ground for Woolworths Holdings' significant 23% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Woolworths Holdings' growth is quite high when compared to the industry average growth of 7.6% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Woolworths Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is Woolworths Holdings Using Its Retained Earnings Effectively?

Woolworths Holdings' significant three-year median payout ratio of 73% (where it is retaining only 27% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Moreover, Woolworths Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 59%. Accordingly, forecasts suggest that Woolworths Holdings' future ROE will be 29% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with Woolworths Holdings' performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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.