In This Article:
It is hard to get excited after looking at British American Tobacco's (LON:BATS) recent performance, when its stock has declined 8.2% over the past three months. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on British American Tobacco's ROE.
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.
View our latest analysis for British American Tobacco
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for British American Tobacco is:
9.0% = UK£6.8b ÷ UK£76b (Based on the trailing twelve months to December 2022).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.09 in profit.
What Has ROE Got To Do With 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of British American Tobacco's Earnings Growth And 9.0% ROE
On the face of it, British American Tobacco's ROE is not much to talk about. Next, when compared to the average industry ROE of 15%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 43% seen by British American Tobacco was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared British American Tobacco's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 8.2% in the same period.
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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about British American Tobacco's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.