Baby Bunting Group's's (ASX:BBN) stock is up by a considerable 49% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Baby Bunting Group'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To 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 Baby Bunting Group is:
13% = AU$12m ÷ AU$93m (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.13.
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. 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 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.
Baby Bunting Group's Earnings Growth And 13% ROE
To begin with, Baby Bunting Group seems to have a respectable ROE. Even when compared to the industry average of 16% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 12% seen over the past five years by Baby Bunting Group.
We then performed a comparison between Baby Bunting Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 14% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Baby Bunting Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Baby Bunting Group Using Its Retained Earnings Effectively?
While Baby Bunting Group has a three-year median payout ratio of 81% (which means it retains 19% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Additionally, Baby Bunting Group has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 66% of its profits over the next three years. However, Baby Bunting Group's ROE is predicted to rise to 20% despite there being no anticipated change in its payout ratio.
In total, we are pretty happy with Baby Bunting Group's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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