Most readers would already know that Ross Stores' (NASDAQ:ROST) stock increased by 7.5% over the past three months. Since the market usually pay for a company's long-term financial health, we decided to study the company's fundamentals to see if they could be influencing the market. Particularly, we will be paying attention to Ross Stores' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To 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 Ross Stores is:

40% = US$2.0b ÷ US$4.9b (Based on the trailing twelve months to May 2024).

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 $0.40 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Ross Stores' Earnings Growth And 40% ROE

Firstly, we acknowledge that Ross Stores has a significantly high ROE. Secondly, even when compared to the industry average of 19% the company's ROE is quite impressive. This likely paved the way for the modest 9.7% net income growth seen by Ross Stores over the past five years.

Next, on comparing with the industry net income growth, we found that Ross Stores' reported growth was lower than the industry growth of 23% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is ROST worth today? The intrinsic value infographic in our free research report helps visualize whether ROST is currently mispriced by the market.

Is Ross Stores Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 26% (implying that the company retains 74% of its profits), it seems that Ross Stores is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Ross Stores 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. 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 24%. As a result, Ross Stores' ROE is not expected to change by much either, which we inferred from the analyst estimate of 39% for future ROE.

Conclusion

In total, we are pretty happy with Ross Stores' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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 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.

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