The Timken Company's (NYSE:TKR) Stock Is Going Strong: Is the Market Following Fundamentals?

Timken's (NYSE:TKR) stock is up by a considerable 11% over the past week. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Timken

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 Timken is:

14% = US$393m ÷ US$2.7b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.14 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.

Timken's Earnings Growth And 14% ROE

At first glance, Timken seems to have a decent ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. This certainly adds some context to Timken's moderate 5.9% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Timken's reported growth was lower than the industry growth of 8.9% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. 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 TKR? You can find out in our latest intrinsic value infographic research report.

Is Timken Making Efficient Use Of Its Profits?

Timken has a low three-year median payout ratio of 24%, meaning that the company retains the remaining 76% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 20% of its profits over the next three years. As a result, Timken's ROE is not expected to change by much either, which we inferred from the analyst estimate of 17% for future ROE.

Summary

Overall, we are quite pleased with Timken's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com