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It’s hard to get excited looking at the recent performance of Barratt Developments (LON:BDEV) when the stock is down 22% over the past three months. However, stock prices are usually driven over the long term by a company’s financials, which in this case look quite respectable. In this article, we’ve decided to focus on Barratt Developments’ ROE.
Return on equity, or ROE, is a test of how effectively a company is increasing its value and managing investors’ money. In other words, it is a profitability metric that measures the return on capital provided by the company’s shareholders.
Check out our latest analysis for Barratt Developments
How is ROE calculated?
The ROE can be calculated using the following formula:
Return on Equity = Net Income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for Barratt Developments is:
12% = £662 million ÷ £5.6 billion (based on trailing 12 months to December 2021).
The “return” is the profit of the last twelve months. This means that for every £1 of equity the company makes £0.12 of profit.
What does ROE have to do with earnings growth?
We have already established that ROE serves as an efficient profitable measure of a company’s future profits. Based on how much of its profits the company reinvests, or “retains,” we are then able to assess a company’s future ability to generate profits. Assuming all else remains the same, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.
Barratt Developments earnings growth and 12% ROE
At first glance, Barratt Developments appears to have a decent ROE. Even compared to the industry average of 11%, the company’s ROE looks pretty decent. Although Barratt Developments has a pretty respectable ROE, its five-year net income decline rate was 2.3%. So there could be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or that the company has allocated capital poorly, for example.
Next, we compared Barratt Developments’ performance to the industry and found that the industry shrank its earnings by 8.2% over the same period, suggesting that the company’s earnings have shrunk at a slower rate than its industry, although it hasn’t is particularly good, it is also not particularly bad.
Earnings growth is an important metric to consider when evaluating a stock. 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. A good indicator of expected earnings growth is the price-to-earnings ratio, which determines the price the market is willing to pay for a stock based on its earnings prospects. So you should check to see if Barratt Developments is trading at a high P/E or low P/E relative to its industry.
Is Barratt Developments using its retained earnings effectively?
Despite a normal three-year median payout ratio of 37% (ie, a 63% retention ratio), the fact that Barratt Developments’ earnings have contracted is quite confusing. It looks like there could be some other reasons to explain the lack in this regard. For example, business could be declining.
Additionally, Barratt Developments has paid dividends over a nine-year period, suggesting that management prefers to maintain dividend payments even though earnings have declined. Studying the latest analyst consensus data, we found that the company’s future payout ratio is expected to increase to 78% over the next three years. Despite the expected higher payout ratio, the company’s ROE is not expected to change significantly.
summary
Overall, we think Barratt Developments certainly has some positive factors to consider. However, given the high ROE and high earnings retention, we would expect the company to deliver strong earnings growth, but that’s not the case here. This suggests that there could be an external threat to the company that is hampering its growth. Against this background, the latest forecasts from industry analysts indicate that the analysts expect a huge improvement in the company’s earnings growth rate. To learn more about the latest analyst forecasts for the company, check out this visualization of analyst forecasts for the company.
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This Simply Wall St article is of a general nature. We provide comments based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
