It is hard to get excited after looking at Coles Group's (ASX:COL) recent performance, when its stock has declined 15% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Coles Group's  ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Coles Group

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Coles Group is:

31% = AU$1.0b ÷ AU$3.4b (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.31 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Coles Group's Earnings Growth And 31% ROE

Firstly, we acknowledge that Coles Group has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 24% also doesn't go unnoticed by us. Despite this, Coles Group's five year net income growth was quite flat over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.



As a next step, we compared Coles Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 19% in the same period. past-earnings-growth

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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for COL? You can find out in our latest intrinsic value infographic research report.

Is Coles Group Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 80% (implying that the company keeps only 20% of its income) of its business to reinvest into its business), most of Coles Group's profits are being paid to shareholders, which explains the absence of growth in earnings.

Additionally, Coles Group has paid dividends over a period of four years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. 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 82%. Accordingly, forecasts suggest that Coles Group's future ROE will be 32% which is again, similar to the current ROE.

Summary

Overall, we feel that Coles Group certainly does have some positive factors to consider. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.