Are Robust Financials Driving The Recent Rally In Donaldson Company, Inc.'s (NYSE:DCI) Stock?

Donaldson Company (NYSE:DCI) has had a great run on the share market with its stock up by a significant 12% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Donaldson Company'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Donaldson Company

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Donaldson Company is:

27% = US$376m ÷ US$1.4b (Based on the trailing twelve months to January 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.27 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Donaldson Company's Earnings Growth And 27% ROE

To begin with, Donaldson Company has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. This probably laid the groundwork for Donaldson Company's moderate 7.4% net income growth seen over the past five years.

As a next step, we compared Donaldson Company's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 7.4% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is DCI fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Donaldson Company Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 33% (implying that the company retains 67% of its profits), it seems that Donaldson Company is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Donaldson Company 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 24% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

In total, we are pretty happy with Donaldson Company's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.