It is hard to get excited after looking at GWA Group's (ASX:GWA) recent performance, when its stock has declined 4.8% over the past month. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on GWA Group'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for GWA Group

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 GWA Group is:

12% = AU$37m ÷ AU$306m (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of GWA Group's Earnings Growth And 12% ROE

To start with, GWA Group's ROE looks acceptable. On comparing with the average industry ROE of 8.9% the company's ROE looks pretty remarkable. Given the circumstances, we can't help but wonder why GWA Group saw little to no growth in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared GWA Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 11% in the same period.

Earnings growth is an important metric to consider when valuing 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 GWA fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is GWA Group Efficiently Re-investing Its Profits?

GWA Group's very high three-year median payout ratio of 102% suggests that the company is paying its shareholders more than what it is earning. The absence in growth is therefore not surprising. Paying a dividend higher than reported profits is not a sustainable move. That's a huge risk in our books.

In addition, GWA Group has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 85% of its profits over the next three years. Still, forecasts suggest that GWA Group's future ROE will rise to 17% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that the performance shown by GWA Group can be open to many interpretations. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.