Weak Financial Prospects Seem To Be Dragging Down Taylor Wimpey plc (LON:TW.) Stock

It is hard to get excited after looking at Taylor Wimpey's (LON:TW.) recent performance, when its stock has declined 6.1% over the past month. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on Taylor Wimpey's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Taylor Wimpey

How Do You Calculate Return On Equity?

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 Taylor Wimpey is:

5.6% = UK£246m ÷ UK£4.4b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.06 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. 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 Taylor Wimpey's Earnings Growth And 5.6% ROE

When you first look at it, Taylor Wimpey's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.8% either. For this reason, Taylor Wimpey's five year net income decline of 5.7% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

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 2.4% 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). This then helps them determine if the stock is placed for a bright or bleak future. 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's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 60% (or a retention ratio of 40%). 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 3 risks we have identified for Taylor Wimpey visit our risks dashboard for free.

In addition, Taylor Wimpey has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 75% over the next three years. Still, forecasts suggest that Taylor Wimpey's future ROE will rise to 9.4% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business 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. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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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.