Most readers would already be aware that KB Home's (NYSE:KBH) stock increased significantly by 6.1% over the past month. 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 KB Home'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 Do You 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 KB Home is:

15% = US$615m ÷ US$4.0b (Based on the trailing twelve months to August 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.15 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. 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. 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.

A Side By Side comparison of KB Home's Earnings Growth And 15% ROE

To start with, KB Home's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. This probably goes some way in explaining KB Home's moderate 19% growth over the past five years amongst other factors.

Next, on comparing KB Home's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 19% over the last few years.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is KB Home fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is KB Home Using Its Retained Earnings Effectively?

KB Home's three-year median payout ratio to shareholders is 9.0% (implying that it retains 91% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, KB Home is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 11% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

Overall, we are quite pleased with KB Home's performance. 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.

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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.