It is hard to get excited after looking at PGG Wrightson's (NZSE:PGW) recent performance, when its stock has declined 3.9% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to PGG Wrightson'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for PGG Wrightson
How To Calculate Return On Equity?
Return on equity 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 PGG Wrightson is:
14% = NZ$24m ÷ NZ$173m (Based on the trailing twelve months to June 2022).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.14 in profit.
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. 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. 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 PGG Wrightson's Earnings Growth And 14% ROE
To start with, PGG Wrightson's ROE looks acceptable. On comparing with the average industry ROE of 9.0% the company's ROE looks pretty remarkable. For this reason, PGG Wrightson's five year net income decline of 9.1% raises the question as to why the high ROE didn't translate into earnings growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 4.5% in the same period, we found that PGG Wrightson's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
Earnings growth is an important metric to consider when valuing a stock. 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. 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 PGG Wrightson is trading on a high P/E or a low P/E, relative to its industry.
Is PGG Wrightson Making Efficient Use Of Its Profits?
With a high three-year median payout ratio of 91% (implying that 8.7% of the profits are retained), most of PGG Wrightson's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely.
Additionally, PGG Wrightson has paid dividends over a period of nine years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 96%. Accordingly, forecasts suggest that PGG Wrightson's future ROE will be 14% which is again, similar to the current ROE.
On the whole, we feel that the performance shown by PGG Wrightson can be open to many interpretations. In spite of the high ROE, the company has failed to see growth in its earnings due to it paying out most of its profits as dividend, with almost nothing left to invest into its own business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.
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