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Is Weakness In Richelieu Hardware Ltd. (TSE:RCH) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

·3-min read

It is hard to get excited after looking at Richelieu Hardware's (TSE:RCH) recent performance, when its stock has declined 24% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Richelieu Hardware's ROE in this article.

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.

View our latest analysis for Richelieu Hardware

How To 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 Richelieu Hardware is:

22% = CA$152m ÷ CA$697m (Based on the trailing twelve months to February 2022).

The 'return' is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.22 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. 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. 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.

Richelieu Hardware's Earnings Growth And 22% ROE

To begin with, Richelieu Hardware has a pretty high ROE which is interesting. Even when compared to the industry average of 23% the company's ROE is pretty decent. The high ROE therefore is what most likely laid the ground for the decent growth of 16% seen over the past five years by Richelieu Hardware.

Next, on comparing Richelieu Hardware's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 18% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is RCH worth today? The intrinsic value infographic in our free research report helps visualize whether RCH is currently mispriced by the market.

Is Richelieu Hardware Efficiently Re-investing Its Profits?

In Richelieu Hardware's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 14% (or a retention ratio of 86%), which suggests that the company is investing most of its profits to grow its business.

Additionally, Richelieu Hardware has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 23% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 17%) over the same period.

Summary

On the whole, we feel that Richelieu Hardware's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.