Is Weakness In Emerson Electric Co. (NYSE:EMR) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 1.4% over the past three months, it is easy to disregard Emerson Electric (NYSE:EMR). 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 Emerson Electric'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Emerson Electric is:

20% = US$3.2b ÷ US$16b (Based on the trailing twelve months to June 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.20 in profit.

Why Is ROE Important For 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. 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.

Emerson Electric's Earnings Growth And 20% ROE

To begin with, Emerson Electric seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. This probably laid the ground for Emerson Electric's moderate 8.9% net income growth seen over the past five years.

Next, on comparing Emerson Electric's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 9.8% in the same period.

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). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for EMR? You can find out in our latest intrinsic value infographic research report.

Is Emerson Electric Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 55% (or a retention ratio of 45%) for Emerson Electric suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Emerson Electric 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 drop to 44% over the next three years. As a result, the expected drop in Emerson Electric's payout ratio explains the anticipated rise in the company's future ROE to 27%, over the same period.

Conclusion

Overall, we are quite pleased with Emerson Electric'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, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.