Declining Stock and Solid Fundamentals: Is The Market Wrong About Woolworths Holdings Limited (JSE:WHL)?

Woolworths Holdings (JSE:WHL) has had a rough three months with its share price down 14%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Woolworths Holdings' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Woolworths Holdings

How To 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 Woolworths Holdings is:

31% = R3.7b ÷ R12b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. That means that for every ZAR1 worth of shareholders' equity, the company generated ZAR0.31 in profit.

What Has ROE Got To Do With 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Woolworths Holdings' Earnings Growth And 31% ROE

Firstly, we acknowledge that Woolworths Holdings has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 7.6% also doesn't go unnoticed by us. Under the circumstances, Woolworths Holdings' considerable five year net income growth of 36% was to be expected.

As a next step, we compared Woolworths Holdings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.4%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Woolworths Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Woolworths Holdings Using Its Retained Earnings Effectively?

Woolworths Holdings' significant three-year median payout ratio of 64% (where it is retaining only 36% 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.

Besides, Woolworths Holdings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its 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 71%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 32%.

Summary

On the whole, we feel that Woolworths Holdings' performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.