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Big 5 Sporting Goods' (NASDAQ:BGFV) stock is up by a considerable 17% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Big 5 Sporting Goods' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Do You Calculate Return On Equity?
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 Big 5 Sporting Goods is:
41% = US$108m ÷ US$263m (Based on the trailing twelve months to July 2021).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.41.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Big 5 Sporting Goods' Earnings Growth And 41% ROE
Firstly, we acknowledge that Big 5 Sporting Goods has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 28% which is quite remarkable. So, the substantial 46% net income growth seen by Big 5 Sporting Goods over the past five years isn't overly surprising.
Next, on comparing with the industry net income growth, we found that Big 5 Sporting Goods' growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.
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. 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 Big 5 Sporting Goods is trading on a high P/E or a low P/E, relative to its industry.
Is Big 5 Sporting Goods Making Efficient Use Of Its Profits?
Big 5 Sporting Goods' ' three-year median payout ratio is on the lower side at 10% implying that it is retaining a higher percentage (90%) of its profits. So it looks like Big 5 Sporting Goods is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Moreover, Big 5 Sporting Goods 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.
Overall, we are quite pleased with Big 5 Sporting Goods' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 3 risks we have identified for Big 5 Sporting Goods by visiting our risks dashboard for free on our platform here.
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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