Bodycote plc (LON:BOY) Stock's On A Decline: Are Poor Fundamentals The Cause?

It is hard to get excited after looking at Bodycote's (LON:BOY) recent performance, when its stock has declined 22% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Bodycote's ROE.

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.

See our latest analysis for Bodycote

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 Bodycote is:

8.5% = UK£64m ÷ UK£748m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.09 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Bodycote's Earnings Growth And 8.5% ROE

At first glance, Bodycote's ROE doesn't look very promising. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. As a result, Bodycote reported a very low income growth of 4.1% over the past five years.

As a next step, we compared Bodycote'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 9.3% 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. This then helps them determine if the stock is placed for a bright or bleak future. Is Bodycote fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Bodycote Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 59% (that is, the company retains only 41% of its income) over the past three years for Bodycote suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Moreover, Bodycote has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 42% over the next three years. As a result, the expected drop in Bodycote's payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.

Conclusion

Overall, we would be extremely cautious before making any decision on Bodycote. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.