W.W. Grainger (NYSE:GWW) has had a great run on the share market with its stock up by a significant 22% over the last 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 W.W. Grainger's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for W.W. Grainger is:

49% = US$1.9b ÷ US$3.9b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.49 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. 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 W.W. Grainger's Earnings Growth And 49% ROE

First thing first, we like that W.W. Grainger has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 17% which is quite remarkable. Under the circumstances, W.W. Grainger's considerable five year net income growth of 22% was to be expected.

Next, on comparing W.W. Grainger'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.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 W.W. Grainger fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is W.W. Grainger Using Its Retained Earnings Effectively?

W.W. Grainger's ' three-year median payout ratio is on the lower side at 21% implying that it is retaining a higher percentage (79%) of its profits. So it looks like W.W. Grainger is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, W.W. Grainger has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 19% of its profits over the next three years. As a result, W.W. Grainger's ROE is not expected to change by much either, which we inferred from the analyst estimate of 45% for future ROE.

Conclusion

On the whole, we feel that W.W. Grainger's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.

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