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Goodwin (LON:GDWN) has had a rough three months with its share price down 3.8%. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Particularly, we will be paying attention to Goodwin's ROE today.
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.
How Do You 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 Goodwin is:
6.6% = UK£7.2m ÷ UK£109m (Based on the trailing twelve months to October 2020).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.07 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
A Side By Side comparison of Goodwin's Earnings Growth And 6.6% ROE
At first glance, Goodwin's ROE doesn't look very promising. Next, when compared to the average industry ROE of 9.0%, the company's ROE leaves us feeling even less enthusiastic. As a result, Goodwin reported a very low income growth of 2.6% over the past five years.
As a next step, we compared Goodwin's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.2% in the same period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Goodwin's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Goodwin Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 62% (that is, the company retains only 38% of its income) over the past three years for Goodwin suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.
Additionally, Goodwin 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.
Overall, we would be extremely cautious before making any decision on Goodwin. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. To know the 2 risks we have identified for Goodwin visit our risks dashboard for free.
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.
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