PriceSmart (NASDAQ:PSMT) has had a rough month with its share price down 7.9%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study PriceSmart’s ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To Calculate Return On Equity?
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 PriceSmart is:
11% = US$104m ÷ US$954m (Based on the trailing twelve months to February 2022).
The ‘return’ is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.11 in profit.
What Is The Relationship Between ROE And 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.
PriceSmart’s Earnings Growth And 11% ROE
At first glance, PriceSmart seems to have a decent ROE. Further, the company’s ROE is similar to the industry average of 13%. PriceSmart’s decent returns aren’t reflected in PriceSmart’smediocre five year net income growth average of 3.3%. A few likely reasons that could be keeping earnings growth low are – the company has a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that PriceSmart’s reported growth was lower than the industry growth of 7.8% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is PriceSmart fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is PriceSmart Making Efficient Use Of Its Profits?
Despite having a moderate three-year median payout ratio of 27% (implying that the company retains the remaining 73% of its income), PriceSmart’s earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, PriceSmart has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
In total, it does look like PriceSmart has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn’t the case here. This suggests that there might be some external threat to the business, that’s hampering its growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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.