Costco Wholesale's (NASDAQ:COST) stock is up by a considerable 14% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Costco Wholesale's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Costco Wholesale

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 Costco Wholesale is:

31% = US$7.6b ÷ US$24b (Based on the trailing twelve months to November 2024).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.31.

What Has ROE Got To Do With 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 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.

Costco Wholesale's Earnings Growth And 31% ROE

First thing first, we like that Costco Wholesale has an impressive ROE. Secondly, even when compared to the industry average of 15% the company's ROE is quite impressive. This likely paved the way for the modest 14% net income growth seen by Costco Wholesale over the past five years.

As a next step, we compared Costco Wholesale's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 12% in the same period.

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. Is COST fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Costco Wholesale Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 26% (implying that the company retains 74% of its profits), it seems that Costco Wholesale is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Costco Wholesale 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 21%. Accordingly, forecasts suggest that Costco Wholesale's future ROE will be 26% which is again, similar to the current ROE.

Conclusion

Overall, we are quite pleased with Costco Wholesale's 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.