September 28, 2020

Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Barrett Business Services’ (NASDAQ:BBSI) recent performance, when its stock has declined 11% over the past month. 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 Barrett Business Services’ ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.

Check out our latest analysis for Barrett Business Services

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 Barrett Business Services is:

25% = US$45m ÷ US$180m (Based on the trailing twelve months to June 2020).

The ‘return’ is the yearly profit. That means that for every $1 worth of shareholders’ equity, the company generated $0.25 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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. 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.

A Side By Side comparison of Barrett Business Services’ Earnings Growth And 25% ROE

First thing first, we like that Barrett Business Services has an impressive ROE. Secondly, even when compared to the industry average of 11% the company’s ROE is quite impressive. As a result, Barrett Business Services’ exceptional 29% net income growth seen over the past five years, doesn’t come as a surprise.

Next, on comparing with the industry net income growth, we found that Barrett Business Services’ growth is quite high when compared to the industry average growth of 17% in the same period, which is great to see.

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. What is BBSI worth today? The intrinsic value infographic in our free research report helps visualize whether BBSI is currently mispriced by the market.

Is Barrett Business Services Using Its Retained Earnings Effectively?

Barrett Business Services’ ‘ three-year median payout ratio is on the lower side at 20% implying that it is retaining a higher percentage (80%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Additionally, Barrett Business Services 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.

Conclusion

Overall, we are quite pleased with Barrett Business Services’ performance. 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. 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.

This article by Simply Wall St is general in nature. 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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