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Adairs Limited's (ASX:ADH) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Adairs (ASX:ADH) has had a great run on the share market with its stock up by a significant 44% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Adairs' 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.

View our latest analysis for Adairs

How To Calculate Return On Equity?

The formula for ROE is:

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Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Adairs is:

16% = AU$34m ÷ AU$216m (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.16 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Adairs' Earnings Growth And 16% ROE

At first glance, Adairs seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 17%. Despite the moderate return on equity, Adairs has posted a net income growth of 4.7% over the past five years. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Adairs' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 18% in the same 5-year period, which is a bit concerning.

past-earnings-growth
past-earnings-growth

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. 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 Adairs is trading on a high P/E or a low P/E, relative to its industry.

Is Adairs Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 64% (that is, the company retains only 36% of its income) over the past three years for Adairs suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Moreover, Adairs has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 68% of its profits over the next three years. Accordingly, forecasts suggest that Adairs' future ROE will be 19% which is again, similar to the current ROE.

Conclusion

Overall, we feel that Adairs certainly does have some positive factors to consider. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

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

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.