Is Graco Inc.'s (NYSE:GGG) Latest Stock Performance Being Led By Its Strong Fundamentals?

Graco's (NYSE:GGG) stock up by 4.4% over the past week. 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 Graco's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Graco

How Do You Calculate Return On Equity?

ROE 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 Graco is:

25% = US$442m ÷ US$1.8b (Based on the trailing twelve months to July 2022).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.25 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 Graco's Earnings Growth And 25% ROE

Firstly, we acknowledge that Graco has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. This probably laid the groundwork for Graco's moderate 16% net income growth seen over the past five years.

As a next step, we compared Graco's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.6%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for GGG? You can find out in our latest intrinsic value infographic research report.

Is Graco Efficiently Re-investing Its Profits?

Graco has a three-year median payout ratio of 32%, which implies that it retains the remaining 68% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Graco 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. 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 33%. Accordingly, forecasts suggest that Graco's future ROE will be 23% which is again, similar to the current ROE.

Summary

On the whole, we feel that Graco's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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.

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