Taylor Wimpey (LON:TW.) has had a rough three months with its share price down 15%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Taylor Wimpey's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Taylor Wimpey is:
5.4% = UK£217m ÷ UK£4.0b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.05 in profit.
Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Taylor Wimpey's Earnings Growth And 5.4% ROE
When you first look at it, Taylor Wimpey's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 5.8%. But then again, Taylor Wimpey's five year net income shrunk at a rate of 3.3%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.
As a next step, we compared Taylor Wimpey's performance with the industry and found thatTaylor Wimpey's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 1.5% in the same period, which is a slower than the company.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Taylor Wimpey's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Taylor Wimpey Efficiently Re-investing Its Profits?
Looking at its three-year median payout ratio of 28% (or a retention ratio of 72%) which is pretty normal, Taylor Wimpey's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Moreover, Taylor Wimpey has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 63% over the next three years. However, Taylor Wimpey's future ROE is expected to rise to 15% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.
On the whole, we feel that the performance shown by Taylor Wimpey can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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