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Most readers would already be aware that Redrow's (LON:RDW) stock increased significantly by 26% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Redrow's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Redrow
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 Redrow is:
15% = UK£298m ÷ UK£2.0b (Based on the trailing twelve months to July 2023).
The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.15.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Redrow's Earnings Growth And 15% ROE
To start with, Redrow's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 10%. As you might expect, the 7.5% net income decline reported by Redrow is a bit of a surprise. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
As a next step, we compared Redrow's performance with the industry and found thatRedrow's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 3.6% in the same period, which is a slower than the company.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Redrow is trading on a high P/E or a low P/E, relative to its industry.