Yahoo Finance Barratt Developments plc's (LON:BDEV) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
Barratt Developments (LON:BDEV) has had a great run on the share market with its stock up by a significant 6.9% over the last month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Barratt Developments' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Barratt Developments
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Barratt Developments is:
9.6% = UK£545m ÷ UK£5.7b (Based on the trailing twelve months to December 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.10 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 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.
Barratt Developments' Earnings Growth And 9.6% ROE
At first glance, Barratt Developments seems to have a decent ROE. Even when compared to the industry average of 10% the company's ROE looks quite decent. For this reason, Barratt Developments' five year net income decline of 5.6% raises the question as to why the decent ROE didn't translate into growth. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 4.5% in the same period, we still found Barratt Developments' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is BDEV fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Barratt Developments Making Efficient Use Of Its Profits?
In spite of a normal three-year median payout ratio of 47% (that is, a retention ratio of 53%), the fact that Barratt Developments' earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Barratt Developments has been paying dividends over a period of nine years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 60% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.
Summary
On the whole, we do feel that Barratt Developments has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. Additionally, the latest industry analyst forecasts show that analysts expect the company's earnings to continue to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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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