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Do Its Financials Have Any Role To Play In Driving Redrow plc's (LON:RDW) Stock Up Recently?

Redrow (LON:RDW) has had a great run on the share market with its stock up by a significant 12% over the last 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. Particularly, we will be paying attention to Redrow's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See 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:

14% = UK£254m ÷ UK£1.9b (Based on the trailing twelve months to June 2021).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.14 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Redrow's Earnings Growth And 14% ROE

At first glance, Redrow seems to have a decent ROE. On comparing with the average industry ROE of 8.7% the company's ROE looks pretty remarkable. For this reason, Redrow's five year net income decline of 4.8% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Redrow's performance with the industry and discovered the industry has shrunk at a rate of 6.5% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. While this is not particularly good, its not particularly bad either.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for RDW? You can find out in our latest intrinsic value infographic research report.

Is Redrow Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 31% (that is, a retention ratio of 69%), the fact that Redrow's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Redrow has been paying dividends over a period of eight years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 37% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Conclusion

On the whole, we do feel that Redrow has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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