Reliance Worldwide's (ASX:RWC) stock is up by 9.0% 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 Reliance Worldwide's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
Return on equity 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:
8.8% = AU$131m ÷ AU$1.5b (Based on the trailing twelve months to December 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.09 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. 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.
Reliance Worldwide's Earnings Growth And 8.8% ROE
When you first look at it, Reliance Worldwide's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 10%, we may spare it some thought. Moreover, we are quite pleased to see that Reliance Worldwide's net income grew significantly at a rate of 31% over the last five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Reliance Worldwide's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 4.8% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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 RWC fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Reliance Worldwide Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 69% (implying that it keeps only 31% of profits) for Reliance Worldwide suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Additionally, Reliance Worldwide has paid dividends over a period of four 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 is expected to drop to 54% over the next three years. As a result, the expected drop in Reliance Worldwide's payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.
In total, it does look like Reliance Worldwide has some positive aspects to its business. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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