WD-40 (NASDAQ:WDFC) has had a great run on the share market with its stock up by a significant 19% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to WD-40's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 WD-40 is:
41% = US$72m ÷ US$175m (Based on the trailing twelve months to November 2020).
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 $0.41 in profit.
What Has ROE Got To Do With 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 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.
WD-40's Earnings Growth And 41% ROE
Firstly, we acknowledge that WD-40 has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 24% which is quite remarkable. This probably laid the groundwork for WD-40's moderate 5.1% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that WD-40's reported growth was lower than the industry growth of 11% in the same period, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. 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 WD-40's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is WD-40 Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 52% (or a retention ratio of 48%) for WD-40 suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Additionally, WD-40 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.
Overall, we feel that WD-40 certainly does have some positive factors to consider. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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