PACCAR (NASDAQ:PCAR) has had a rough month with its share price down 4.4%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to PACCAR's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 PACCAR is:
15% = US$1.7b ÷ US$11b (Based on the trailing twelve months to September 2021).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.15 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
PACCAR's Earnings Growth And 15% ROE
To start with, PACCAR's ROE looks acceptable. Especially when compared to the industry average of 13% the company's ROE looks pretty impressive. This certainly adds some context to PACCAR's decent 7.6% net income growth seen over the past five years.
Next, on comparing PACCAR's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 8.5% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is PCAR fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is PACCAR Efficiently Re-investing Its Profits?
PACCAR's three-year median payout ratio to shareholders is 21% (implying that it retains 79% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Moreover, PACCAR is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 33% over the next three years. Still, forecasts suggest that PACCAR's future ROE will rise to 20% 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.
On the whole, we feel that PACCAR's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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.
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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.