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Greggs plc's (LON:GRG) Recent Stock Performance Looks Decent- Can Strong Fundamentals Be the Reason?

Most readers would already know that Greggs' (LON:GRG) stock increased by 6.5% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Greggs' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Greggs

How Is ROE Calculated?

The formula for return on equity is:

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

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

27% = UK£120m ÷ UK£446m (Based on the trailing twelve months to December 2022).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.27 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Greggs' Earnings Growth And 27% ROE

Firstly, we acknowledge that Greggs has a significantly high ROE. Secondly, even when compared to the industry average of 8.5% the company's ROE is quite impressive. This likely paved the way for the modest 16% net income growth seen by Greggs over the past five years. growth

When you consider the fact that the industry earnings have shrunk at a rate of 9.5% in the same period, the company's net income growth is pretty remarkable.

past-earnings-growth
past-earnings-growth

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Greggs''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Greggs Efficiently Re-investing Its Profits?

Greggs has a healthy combination of a moderate three-year median payout ratio of 36% (or a retention ratio of 64%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, Greggs 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 51% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

On the whole, we feel that Greggs' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

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