Grafton Group's (LON:GFTU) stock is up by a considerable 12% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Grafton Group's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Grafton Group

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 Grafton Group is:

8.2% = UK￡131m ÷ UK￡1.6b (Based on the trailing twelve months to June 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 ￡0.08 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. 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. 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.

Grafton Group's Earnings Growth And 8.2% ROE

At first glance, Grafton Group's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. Although, we can see that Grafton Group saw a modest net income growth of 5.2% over the past five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Grafton Group's reported growth was lower than the industry growth of 14% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is GFTU fairly valued? This infographic on the company's intrinsic value has everything you need to know.