Most readers would already be aware that Reliance Worldwide's (ASX:RWC) stock increased significantly by 27% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Reliance Worldwide's ROE today.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Reliance Worldwide is:
12% = AU$188m ÷ AU$1.6b (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.12 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
Reliance Worldwide's Earnings Growth And 12% ROE
To start with, Reliance Worldwide's ROE looks acceptable. On comparing with the average industry ROE of 8.4% the company's ROE looks pretty remarkable. This probably laid the ground for Reliance Worldwide's significant 34% net income growth seen over the past five years. However, there could also be other causes 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 Reliance Worldwide's growth is quite high when compared to the industry average growth of 6.9% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. 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 RWC fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Reliance Worldwide Using Its Retained Earnings Effectively?
Reliance Worldwide's significant three-year median payout ratio of 73% (where it is retaining only 27% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.
Additionally, Reliance Worldwide has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 52% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
Overall, we are quite pleased with Reliance Worldwide's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.