Wesfarmers (ASX:WES) has had a rough three months with its share price down 9.1%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Wesfarmers' ROE.
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 ROEis:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Wesfarmers is:
32% = AU$2.9b ÷ AU$9.2b (Based on the trailing twelve months to June 2025).
The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.32 in profit.
View our latest analysis for Wesfarmers
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.
Wesfarmers' Earnings Growth And 32% ROE
First thing first, we like that Wesfarmers has an impressive ROE. Secondly, even when compared to the industry average of 10% the company's ROE is quite impressive. This likely paved the way for the modest 7.7% net income growth seen by Wesfarmers over the past five years.
Next, on comparing Wesfarmers' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 6.8% 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. If you're wondering about Wesfarmers''s valuation, check out this gauge of its price-to-earnings ratio , as compared to its industry.
Is Wesfarmers Using Its Retained Earnings Effectively?
Wesfarmers has a significant three-year median payout ratio of 88%, meaning that it is left with only 12% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Moreover, Wesfarmers 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 is expected to keep paying out approximately 87% of its profits over the next three years. As a result, Wesfarmers' ROE is not expected to change by much either, which we inferred from the analyst estimate of 37% for future ROE.
Conclusion
Overall, we are quite pleased with Wesfarmers' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.
