Pentair plc's (NYSE:PNR) Stock Is Going Strong: Have Financials A Role To Play?

Pentair's (NYSE:PNR) stock is up by a considerable 15% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Pentair's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Pentair

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 Pentair is:

18% = US$360m ÷ US$2.0b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.18.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Pentair's Earnings Growth And 18% ROE

To begin with, Pentair seems to have a respectable ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. Despite this, Pentair's five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.

As a next step, we compared Pentair's net income growth with the industry and discovered that the industry saw an average growth of 9.4% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Pentair's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Pentair Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 48% (or a retention ratio of 52%), Pentair hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Pentair has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 28% over the next three years. As a result, the expected drop in Pentair's payout ratio explains the anticipated rise in the company's future ROE to 23%, over the same period.

Summary

In total, it does look like Pentair has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. 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.
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