Procter & Gamble (NYSE:PG) has had a great run on the share market with its stock up by a significant 5.4% over the last month. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Procter & Gamble's ROE today.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for Procter & Gamble
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 Procter & Gamble is:
32% = US$14b ÷ US$45b (Based on the trailing twelve months to December 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.32 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Procter & Gamble's Earnings Growth And 32% ROE
Firstly, we acknowledge that Procter & Gamble has a significantly high ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Probably as a result of this, Procter & Gamble was able to see a decent net income growth of 14% over the last five years.
As a next step, we compared Procter & Gamble's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.5%.
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). Doing so will help them establish if the stock's future looks promising or ominous. What is PG worth today? The intrinsic value infographic in our free research report helps visualize whether PG is currently mispriced by the market.
Is Procter & Gamble Making Efficient Use Of Its Profits?
While Procter & Gamble has a three-year median payout ratio of 59% (which means it retains 41% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Besides, Procter & Gamble has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 60%. Accordingly, forecasts suggest that Procter & Gamble's future ROE will be 38% which is again, similar to the current ROE.
Summary
Overall, we are quite pleased with Procter & Gamble's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.