It is hard to get excited after looking at Ulta Beauty's (NASDAQ:ULTA) recent performance, when its stock has declined 10% over the past month. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Ulta Beauty's ROE today.

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.

Check out our latest analysis for Ulta Beauty

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Ulta Beauty is:

44% = US$868m ÷ US$2.0b (Based on the trailing twelve months to October 2021).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.44 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Ulta Beauty's Earnings Growth And 44% ROE

First thing first, we like that Ulta Beauty has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 31% also doesn't go unnoticed by us. Yet, Ulta Beauty has posted measly growth of 2.8% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.

We then compared Ulta Beauty's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 18% in the same period, which is a bit concerning.

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. Doing so will help them establish if the stock's future looks promising or ominous. What is ULTA worth today? The intrinsic value infographic in our free research report helps visualize whether ULTA is currently mispriced by the market.

Is Ulta Beauty Using Its Retained Earnings Effectively?

Ulta Beauty doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This doesn't explain the low earnings growth number that we discussed above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Summary

On the whole, we do feel that Ulta Beauty has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.