Is ESAB Corporation's (NYSE:ESAB) Recent Stock Performance Tethered To Its Strong Fundamentals?

ESAB (NYSE:ESAB) has had a great run on the share market with its stock up by a significant 13% 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. Particularly, we will be paying attention to ESAB'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.

Check out our latest analysis for ESAB

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for ESAB is:

15% = US$269m ÷ US$1.7b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.15 in profit.

Why Is ROE Important For Earnings Growth?

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

ESAB's Earnings Growth And 15% ROE

At first glance, ESAB seems to have a decent ROE. Even when compared to the industry average of 15% the company's ROE looks quite decent. This probably goes some way in explaining ESAB's moderate 7.2% growth over the past five years amongst other factors.

Next, on comparing with the industry net income growth, we found that ESAB's reported growth was lower than the industry growth of 11% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. 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. What is ESAB worth today? The intrinsic value infographic in our free research report helps visualize whether ESAB is currently mispriced by the market.

Is ESAB Efficiently Re-investing Its Profits?

In ESAB's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 5.9% (or a retention ratio of 94%), which suggests that the company is investing most of its profits to grow its business.

While ESAB has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 5.9% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 15%.

Conclusion

In total, we are pretty happy with ESAB's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.