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Woolworths Group Limited's (ASX:WOW) Stock Has Shown A Decent Performance: Have Financials A Role To Play?

Woolworths Group's (ASX:WOW) stock up by 8.0% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, 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 Woolworths Group's ROE today.

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.

View our latest analysis for Woolworths Group

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 Woolworths Group is:

27% = AU$1.7b ÷ AU$6.4b (Based on the trailing twelve months to January 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.27 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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 Group's Earnings Growth And 27% ROE

To begin with, Woolworths Group has a pretty high ROE which is interesting. Even when compared to the industry average of 26% the company's ROE is pretty decent. Despite this, Woolworths Group's five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 17% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is WOW fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Woolworths Group Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 88% (meaning, the company retains only 12% of profits) for Woolworths Group suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

Additionally, Woolworths Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 74%. As a result, Woolworths Group's ROE is not expected to change by much either, which we inferred from the analyst estimate of 26% for future ROE.

Conclusion

On the whole, we do feel that Woolworths Group has some positive attributes. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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