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Is Woolworths Group Limited's (ASX:WOW) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

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·4-min read
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Most readers would already be aware that Woolworths Group's (ASX:WOW) stock increased significantly by 5.1% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Woolworths Group's ROE.

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. 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 Woolworths Group

How To Calculate Return On Equity?

ROE 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 Woolworths Group is:

15% = AU$1.5b ÷ AU$9.7b (Based on the trailing twelve months to January 2021).

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$0.15 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of Woolworths Group's Earnings Growth And 15% ROE

To start with, Woolworths Group's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 15%. For this reason, Woolworths Group's five year net income decline of 7.3% raises the question as to why the decent ROE didn't translate into growth. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

With the industry earnings declining at a rate of 7.3% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Woolworths Group is trading on a high P/E or a low P/E, relative to its industry.

Is Woolworths Group Using Its Retained Earnings Effectively?

Woolworths Group has a high three-year median payout ratio of 89% (that is, it is retaining 11% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Woolworths Group.

Moreover, Woolworths 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 76% of its profits over the next three years. However, Woolworths Group's ROE is predicted to rise to 20% despite there being no anticipated change in its payout ratio.

Summary

Overall, we feel that Woolworths Group certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.

This article by Simply Wall St is general in nature. 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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