Does Worley Limited's (ASX:WOR) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Worley's (ASX:WOR) stock is up by a considerable 16% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Worley's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

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How Is ROE Calculated?

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 Worley is:

6.8% = AU$394m ÷ AU$5.8b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.07.

View our latest analysis for Worley

What Is The Relationship Between ROE And 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.

A Side By Side comparison of Worley's Earnings Growth And 6.8% ROE

On the face of it, Worley's ROE is not much to talk about. Next, when compared to the average industry ROE of 15%, the company's ROE leaves us feeling even less enthusiastic. Worley was still able to see a decent net income growth of 20% over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Worley's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 26% in the same period.

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

Is Worley Using Its Retained Earnings Effectively?

Worley has a very high three-year median payout ratio of 152% suggesting that the company's shareholders are getting paid from more than just the company's earnings. Still the company's earnings have grown respectably. It would still be worth keeping an eye on that high payout ratio, if for some reason the company runs into problems and business deteriorates.

Additionally, Worley 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 is expected to drop to 62% over the next three years. As a result, the expected drop in Worley's payout ratio explains the anticipated rise in the company's future ROE to 9.7%, over the same period.

Summary

In total, we would have a hard think before deciding on any investment action concerning Worley. While no doubt its earnings growth is pretty respectable, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, specially during troubled times. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.