WEBULL

Should Weakness in Adairs Limited's (ASX:ADH) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Simply Wall St · 06/27 02:34

It is hard to get excited after looking at Adairs' (ASX:ADH) recent performance, when its stock has declined 22% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Adairs' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Adairs is:

14% = AU$33m ÷ AU$236m (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.14 in profit.

See our latest analysis for Adairs

Why Is ROE Important For 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. 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.

A Side By Side comparison of Adairs' Earnings Growth And 14% ROE

At first glance, Adairs seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. For this reason, Adairs' five year net income decline of 6.7% raises the question as to why the decent ROE didn't translate into growth. So, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

That being said, we compared Adairs' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.2% in the same 5-year period.

past-earnings-growth
ASX:ADH Past Earnings Growth June 27th 2025

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. 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 Adairs is trading on a high P/E or a low P/E, relative to its industry.

Is Adairs Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 64% (implying that 36% of the profits are retained), most of Adairs' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

In addition, Adairs has been paying dividends over a period of nine years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 66% of its profits over the next three years. Still, forecasts suggest that Adairs' future ROE will rise to 18% even though the the company's payout ratio is not expected to change by much.

Summary

In total, it does look like Adairs has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.