Is Taylor Wimpey plc's (LON:TW.) Stock On A Downtrend As A Result Of Its Poor Financials?

Taylor Wimpey (LON:TW.) has had a rough week with its share price down 5.7%. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Taylor Wimpey's ROE in this article.

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.

View our latest analysis for Taylor Wimpey

How To 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 Taylor Wimpey is:

7.7% = UK£349m ÷ UK£4.5b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.08 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Taylor Wimpey's Earnings Growth And 7.7% ROE

At first glance, Taylor Wimpey's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 7.6%, we may spare it some thought. But then again, Taylor Wimpey's five year net income shrunk at a rate of 3.5%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 2.5% in the same 5-year period, we still found Taylor Wimpey's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is TW. fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Taylor Wimpey Using Its Retained Earnings Effectively?

Taylor Wimpey has a high three-year median payout ratio of 60% (that is, it is retaining 40% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 2 risks we have identified for Taylor Wimpey visit our risks dashboard for free.

Moreover, Taylor Wimpey 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 78% over the next three years. However, Taylor Wimpey's future ROE is expected to rise to 9.6% 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.

Summary

In total, we would have a hard think before deciding on any investment action concerning Taylor Wimpey. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.

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