Yahoo Finance Has Redrow plc's (LON:RDW) Impressive Stock Performance Got Anything to Do With Its Fundamentals?
Most readers would already be aware that Redrow's (LON:RDW) stock increased significantly by 26% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, 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. In this article, we decided to focus on Redrow'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Redrow
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Redrow is:
15% = UK£298m ÷ UK£2.0b (Based on the trailing twelve months to July 2023).
The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.15.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Redrow's Earnings Growth And 15% ROE
To start with, Redrow's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 10%. As you might expect, the 7.5% net income decline reported by Redrow is a bit of a surprise. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
As a next step, we compared Redrow's performance with the industry and found thatRedrow's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 3.6% in the same period, which is a slower than the company.
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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Redrow is trading on a high P/E or a low P/E, relative to its industry.
Is Redrow Efficiently Re-investing Its Profits?
In spite of a normal three-year median payout ratio of 35% (that is, a retention ratio of 65%), the fact that Redrow's 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.
Additionally, Redrow 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 35% of its profits over the next three years. However, Redrow's future ROE is expected to decline to 7.0% despite there being not much change anticipated in the company's payout ratio.
Summary
In total, it does look like Redrow has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. Additionally, the latest industry analyst forecasts show that analysts expect the company's earnings to continue to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.
