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GWA Group Limited's (ASX:GWA) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

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GWA Group (ASX:GWA) has had a great run on the share market with its stock up by a significant 7.5% over the last week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study GWA Group's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for GWA Group

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for GWA Group is:

12% = AU$35m ÷ AU$297m (Based on the trailing twelve months to June 2021).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.12 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

GWA Group's Earnings Growth And 12% ROE

At first glance, GWA Group seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 11%. However, while GWA Group has a pretty respectable ROE, its five year net income decline rate was 7.2% . Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

However, when we compared GWA Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.7% in the same period. This is quite worrisome.

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. Has the market priced in the future outlook for GWA? You can find out in our latest intrinsic value infographic research report.

Is GWA Group Efficiently Re-investing Its Profits?

GWA Group's 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 95% (or a retention ratio of 5.2%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 2 risks we have identified for GWA Group visit our risks dashboard for free.

Moreover, GWA Group 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 73% over the next three years. As a result, the expected drop in GWA Group's payout ratio explains the anticipated rise in the company's future ROE to 17%, over the same period.

Conclusion

Overall, we have mixed feelings about GWA Group. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

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

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