Is Toll Brothers, Inc.'s (NYSE:TOL) Latest Stock Performance A Reflection Of Its Financial Health?

Toll Brothers' (NYSE:TOL) stock is up by a considerable 18% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Toll Brothers' ROE in this article.

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 Toll Brothers

How Do You 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 Toll Brothers is:

20% = US$1.4b ÷ US$7.0b (Based on the trailing twelve months to January 2024).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.20.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Toll Brothers' Earnings Growth And 20% ROE

To begin with, Toll Brothers seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 16%. This certainly adds some context to Toll Brothers' exceptional 23% net income growth seen over the past five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then performed a comparison between Toll Brothers' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 25% in the same 5-year 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. Doing so will help them establish if the stock's future looks promising or ominous. Is Toll Brothers fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Toll Brothers Efficiently Re-investing Its Profits?

Toll Brothers' ' three-year median payout ratio is on the lower side at 8.6% implying that it is retaining a higher percentage (91%) of its profits. So it looks like Toll Brothers is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Toll Brothers is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 6.4% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

In total, we are pretty happy with Toll Brothers' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.