Will Weakness in Otter Tail Corporation's (NASDAQ:OTTR) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at Otter Tail's (NASDAQ:OTTR) recent performance, when its stock has declined 6.9% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Otter Tail'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Otter Tail

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Otter Tail is:

20% = US$311m ÷ US$1.6b (Based on the trailing twelve months to June 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 $0.20.

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. 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.

Otter Tail's Earnings Growth And 20% ROE

To begin with, Otter Tail seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.2%. This certainly adds some context to Otter Tail's exceptional 30% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Otter Tail's growth is quite high when compared to the industry average growth of 6.6% in the same period, which is great 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. If you're wondering about Otter Tail's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Otter Tail Efficiently Re-investing Its Profits?

Otter Tail has a three-year median payout ratio of 25% (where it is retaining 75% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Otter Tail is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Otter Tail has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 55% over the next three years.

Conclusion

Overall, we are quite pleased with Otter Tail'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. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.