Worthington Steel, Inc.'s (NYSE:WS) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 40% over the past three months, it is easy to disregard Worthington Steel (NYSE:WS). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Worthington Steel's ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Worthington Steel

How Do You 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 Worthington Steel is:

14% = US$158m ÷ US$1.1b (Based on the trailing twelve months to November 2024).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.14.

What Is The Relationship Between ROE And Earnings Growth?

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

Worthington Steel's Earnings Growth And 14% ROE

To begin with, Worthington Steel seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Needless to say, we are quite surprised to see that Worthington Steel's net income shrunk at a rate of 6.7% over the past five years. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

That being said, we compared Worthington Steel's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 18% in the same 5-year period.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Worthington Steel fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Worthington Steel Efficiently Re-investing Its Profits?

When we piece together Worthington Steel's low three-year median payout ratio of 15% (where it is retaining 85% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, Worthington Steel only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 18% over the next three years.

Summary

In total, it does look like Worthington Steel has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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. 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.