Most readers would already be aware that Richelieu Hardware's (TSE:RCH) stock increased significantly by 17% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Richelieu Hardware'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Richelieu Hardware is:
21% = CA$142m ÷ CA$669m (Based on the trailing twelve months to November 2021).
The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.21 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Richelieu Hardware's Earnings Growth And 21% ROE
At first glance, Richelieu Hardware seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 22%. This probably goes some way in explaining Richelieu Hardware's moderate 14% growth over the past five years amongst other factors.
As a next step, we compared Richelieu Hardware'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 21% 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. This then helps them determine if the stock is placed for a bright or bleak future. What is RCH worth today? The intrinsic value infographic in our free research report helps visualize whether RCH is currently mispriced by the market.
Is Richelieu Hardware Making Efficient Use Of Its Profits?
In Richelieu Hardware's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 16% (or a retention ratio of 84%), which suggests that the company is investing most of its profits to grow its business.
Moreover, Richelieu Hardware is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 23% over the next three years.
Overall, we are quite pleased with Richelieu Hardware's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings.
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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.