Yahoo Finance Gooch & Housego PLC's (LON:GHH) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?
Most readers would already be aware that Gooch & Housego's (LON:GHH) stock increased significantly by 25% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Gooch & Housego's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Gooch & Housego
How Is ROE Calculated?
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 Gooch & Housego is:
3.4% = UK£4.0m ÷ UK£120m (Based on the trailing twelve months to September 2023).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.03 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Gooch & Housego's Earnings Growth And 3.4% ROE
As you can see, Gooch & Housego's ROE looks pretty weak. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. For this reason, Gooch & Housego's five year net income decline of 27% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
However, when we compared Gooch & Housego's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is GHH fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Gooch & Housego Making Efficient Use Of Its Profits?
With a high three-year median payout ratio of 66% (implying that 34% of the profits are retained), most of Gooch & Housego's profits are being paid to shareholders, which explains the company's shrinking earnings. 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 Gooch & Housego.
Moreover, Gooch & Housego 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's future payout ratio is expected to drop to 30% over the next three years. As a result, the expected drop in Gooch & Housego's payout ratio explains the anticipated rise in the company's future ROE to 8.5%, over the same period.
Summary
On the whole, Gooch & Housego's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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.
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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.
