Costco Wholesale’s (NASDAQ:COST) stock up by 8.0% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Costco Wholesale’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 simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
How Do You 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 Costco Wholesale is:
28% = US$5.6b ÷ US$20b (Based on the trailing twelve months to February 2022).
The ‘return’ refers to a company’s earnings over the last year. So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.28.
Why Is ROE Important For Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.
Costco Wholesale’s Earnings Growth And 28% ROE
Firstly, we acknowledge that Costco Wholesale has a significantly high ROE. Secondly, even when compared to the industry average of 14% the company’s ROE is quite impressive. This likely paved the way for the modest 15% net income growth seen by Costco Wholesale over the past five years. growth
Next, on comparing with the industry net income growth, we found that Costco Wholesale’s growth is quite high when compared to the industry average growth of 7.3% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. 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. Is COST fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is Costco Wholesale Efficiently Re-investing Its Profits?
Costco Wholesale has a three-year median payout ratio of 29%, which implies that it retains the remaining 71% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Additionally, Costco Wholesale has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 22% over the next three years. However, the company’s ROE is not expected to change by much despite the lower expected payout ratio.
On the whole, we feel that Costco Wholesale’s performance has been quite good. In particular, it’s great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company’s earnings growth is expected to slow down. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.