British American Tobacco p.l.c.'s (LON:BATS) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

British American Tobacco’s ROE in this article.” data-reactid=”28″>It is hard to get excited after looking at British American Tobacco’s (LON:BATS) recent performance, when its stock has declined 19% 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. Specifically, we decided to study British American Tobacco’s ROE in this article.

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 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 British American Tobacco ” data-reactid=”30″> View our latest analysis for British American Tobacco

How Is ROE Calculated?

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

So, based on the above formula, the ROE for British American Tobacco is:

9.4% = UK£6.5b ÷ UK£69b (Based on the trailing twelve months to June 2020).

The ‘return’ is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders’ capital it has, the company made £0.09 in profit.

Why Is ROE Important For Earnings Growth?

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

British American Tobacco’s Earnings Growth And 9.4% ROE

To begin with, British American Tobacco seems to have a respectable ROE. Even so, when compared with the average industry ROE of 14%, we aren’t very excited. British American Tobacco was still able to see a decent net income growth of 10% over the past five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also does lend some color to the fairly high earnings growth seen by the company.

Next, on comparing British American Tobacco’s net income growth with the industry, we found that the company’s reported growth is similar to the industry average growth rate of 11% in the same period.

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check if British American Tobacco is trading on a high P/E or a low P/E, relative to its industry.” data-reactid=”58″>Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if British American Tobacco is trading on a high P/E or a low P/E, relative to its industry.

Is British American Tobacco Using Its Retained Earnings Effectively?

While British American Tobacco has a three-year median payout ratio of 74% (which means it retains 26% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn’t hampered its ability to grow.