Declining Stock and Solid Fundamentals: Is The Market Wrong About The Timken Company (NYSE:TKR)?

By
Simply Wall St
Published
February 24, 2022
NYSE:TKR
Source: Shutterstock

With its stock down 6.8% over the past three months, it is easy to disregard Timken (NYSE:TKR). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Timken's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Timken

How To 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 Timken is:

16% = US$382m ÷ US$2.4b (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.16 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Timken's Earnings Growth And 16% ROE

To start with, Timken's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to Timken's decent 16% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Timken's growth is quite high when compared to the industry average growth of 8.7% in the same period, which is great to see.

past-earnings-growth
NYSE:TKR Past Earnings Growth February 24th 2022

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Timken fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Timken Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 26% (implying that the company retains 74% of its profits), it seems that Timken is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Timken has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 19% 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 Timken'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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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