Should Weakness in Shake Shack Inc.'s (NYSE:SHAK) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?
With its stock down 32% over the past three months, it is easy to disregard Shake Shack (NYSE:SHAK). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Shake Shack's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Shake Shack
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Shake Shack is:
6.0% = US$19m ÷ US$323m (Based on the trailing twelve months to March 2020).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.06 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learnt 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 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.
Shake Shack's Earnings Growth And 6.0% ROE
When you first look at it, Shake Shack's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. Despite this, surprisingly, Shake Shack saw an exceptional 47% net income growth over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Shake Shack's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 13%.
Earnings growth is a huge factor in stock valuation. 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. Is Shake Shack fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Shake Shack Efficiently Re-investing Its Profits?
Shake Shack doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.
Conclusion
In total, it does look like Shake Shack has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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