Are Strong Financial Prospects The Force That Is Driving The Momentum In Johnson Matthey Plc's LON:JMAT) Stock?

Most readers would already be aware that Johnson Matthey's (LON:JMAT) stock increased significantly by 16% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Johnson Matthey's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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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 Johnson Matthey is:

22% = UK£529m ÷ UK£2.4b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.22 in profit.

Check out our latest analysis for Johnson Matthey

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Johnson Matthey's Earnings Growth And 22% ROE

To begin with, Johnson Matthey seems to have a respectable ROE. Especially when compared to the industry average of 6.6% the company's ROE looks pretty impressive. However, for some reason, the higher returns aren't reflected in Johnson Matthey's meagre five year net income growth average of 3.7%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Johnson Matthey's growth is quite high when compared to the industry average growth of 0.4% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is JMAT worth today? The intrinsic value infographic in our free research report helps visualize whether JMAT is currently mispriced by the market.

Is Johnson Matthey Making Efficient Use Of Its Profits?

Johnson Matthey has a three-year median payout ratio of 68% (implying that it keeps only 32% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, Johnson Matthey 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 43% over the next three years. Still forecasts suggest that Johnson Matthey's future ROE will drop to 12% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.

Summary

Overall, we are quite pleased with Johnson Matthey's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.