GMS (NYSE:GMS) has had a great run on the share market with its stock up by a significant 12% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to GMS’ ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.

View our latest analysis for GMS

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 GMS is:

21% = US$295m ÷ US$1.4b (Based on the trailing twelve months to January 2024).

The ‘return’ is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.21 in profit.

Why Is ROE Important For Earnings Growth?

So far, we’ve learned that ROE is a measure of a company’s profitability. 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.

GMS’ Earnings Growth And 21% ROE

To begin with, GMS seems to have a respectable ROE. Further, the company’s ROE is similar to the industry average of 18%. This certainly adds some context to GMS’ exceptional 42% net income growth seen over the past five years. However, there could also be other drivers behind this growth. Such as – high earnings retention or an efficient management in place.

As a next step, we compared GMS’ 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 25%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for GMS? You can find out in our latest intrinsic value infographic research report.

Is GMS Efficiently Re-investing Its Profits?

GMS doesn’t pay any regular dividends currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Summary

In total, we are pretty happy with GMS’ performance. 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. With that said, the latest industry analyst forecasts reveal that the company’s earnings growth is expected to slow down. 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.