Is Whitbread plc (LON:WTB)’s recent price action underpinned by its weak fundamentals?

It’s hard to get excited looking at Whitbread’s (LON:WTB) recent performance when the stock is down 11% over the past three months. It seems that the market has completely ignored the positive aspects of the company’s fundamentals and decided to give more weight to the negative aspects. Long-term fundamentals usually drive market outcomes, so it pays to pay close attention. In this article, we have chosen to focus on Whitbread’s 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 Whitbread

How do you calculate return on equity?

That Formula for ROE is:

Return on Equity = Net Income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE for Whitbread is:

1.0% = UK£43m ÷ UK£4.1b (Based on trailing 12 months to March 2022).

The “return” is the profit of the last twelve months. This means that for every £1 of equity the company makes £0.01 of profit.

What is the relationship between ROE and earnings growth?

We have already established that ROE serves as an efficient profitable measure of a company’s future profits. Depending on how much of these earnings the company reinvests, or “retains,” and how effectively it does so, we can assess a company’s earnings growth potential. In general, companies with a high return on equity and earnings retention, all other things being equal, have a higher growth rate than companies that do not share these characteristics.

A head-to-head comparison of Whitbread’s earnings growth and 1.0% ROE

It’s hard to argue that Whitbread’s ROE is a lot of good in and of itself. Even compared to the industry average of 11%, the ROE figure is pretty disappointing. Given the circumstances, the sharp 56% drop in net income Whitbread has seen over the past five years isn’t surprising. We believe there may be other issues negatively impacting the company’s earnings prospects. For example, the company has allocated capital poorly or the company has a very high payout ratio.

As a next step, we benchmarked Whitbread’s performance against the industry and found that Whitbread’s performance is depressing, even compared to the industry, which has shrunk its earnings by 21% over the same period, at a slower pace than the company.

past earnings growth

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. Is Whitbread fairly valued compared to other companies? These 3 evaluation criteria could help you with the decision.

Is Whitbread reinvesting its profits efficiently?

When we add up Whitbread’s low three-year average payout ratio of 22% (with 78% of earnings retained) calculated for the most recent three-year period, we’re puzzled by the lack of growth. The low payout should mean that the company will retain most of its profits and consequently should see some growth. So there could be other explanations in this regard. For example, the company’s business may deteriorate.

Additionally, Whitbread has paid dividends for at least a decade, meaning the company’s management is committed to paying dividends, even if it means little to no earnings growth. Our latest analyst data shows that the company’s future payout ratio is expected to grow to 44% over the next three years. However, Whitbread’s future ROE is expected to increase to 6.4% despite the expected increase in the company’s payout ratio. We conclude that there may be other factors driving the expected growth in the company’s ROE.

Conclusion

Overall, we think Whitbread’s performance is open to many interpretations. While the company has a high reinvestment rate, the low ROE means that all of these reinvestments are of no benefit to investors and, moreover, have a negative impact on earnings growth. However, given the current analyst estimates, we noted that the company’s earnings growth rate is expected to see a huge improvement. To learn more about the latest analyst forecasts for the company, check out this visualization of analyst forecasts for the company.

Do you have any feedback about this article? Concerned about the content? Get in touch directly with us. Alternatively, send an email to the editorial team (at) simplywallst.com.

This Simply Wall St article is of a general nature. We provide commentary 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.

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About Nina Snider

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