Most readers would already be aware that Williams-Sonoma's (NYSE:WSM) stock increased significantly by 35% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Williams-Sonoma's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Williams-Sonoma is:

45% = US$950m ÷ US$2.1b (Based on the trailing twelve months to January 2024).

The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.45 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 Williams-Sonoma's Earnings Growth And 45% ROE

First thing first, we like that Williams-Sonoma has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 19% which is quite remarkable. So, the substantial 24% net income growth seen by Williams-Sonoma over the past five years isn't overly surprising.

Next, on comparing Williams-Sonoma's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 25% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is WSM fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Williams-Sonoma Efficiently Re-investing Its Profits?

Williams-Sonoma's three-year median payout ratio to shareholders is 19%, which is quite low. This implies that the company is retaining 81% of its profits. So it looks like Williams-Sonoma is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Williams-Sonoma has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 30% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

Overall, we are quite pleased with Williams-Sonoma's performance. 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.