Granite Construction's (NYSE:GVA) stock is up by a considerable 18% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Granite Construction's ROE.

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.

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 Granite Construction is:

2.9% = US$30m ÷ US$1.0b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.03.

What Is The Relationship Between ROE And 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. 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.

Granite Construction's Earnings Growth And 2.9% ROE

It is quite clear that Granite Construction's ROE is rather low. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. However, we we're pleasantly surprised to see that Granite Construction grew its net income at a significant rate of 48% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Granite Construction's growth is quite high when compared to the industry average growth of 22% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Granite Construction fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Granite Construction Making Efficient Use Of Its Profits?

The three-year median payout ratio for Granite Construction is 49%, which is moderately low. The company is retaining the remaining 51%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Granite Construction is reinvesting its earnings efficiently.

Moreover, Granite Construction is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 10% over the next three years. The fact that the company's ROE is expected to rise to 30% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we do feel that Granite Construction has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.