Could Johnson Matthey Plc’s (LON:JMAT) weak financials mean the market could correct its share price?

Most readers already know that shares of Johnson Matthey (LON:JMAT) are up 8.1% over the past three months. Given that markets typically pay for a company’s long-term financial health, we wonder if the current share price momentum will keep up, as the company’s financials don’t look very promising. Specifically, we decided to examine Johnson Matthey’s ROE in this article.

ROE, or return on equity, is a useful tool for assessing how effectively a company is generating returns on the investment received from its shareholders. Put simply, it measures a company’s profitability in relation to its equity.

Check out our latest analysis for Johnson Matthey

How do you calculate return on equity?

The ROE can be calculated using the following formula:

Return on Equity = Net Income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE for Johnson Matthey is:

4.8% = UK£116m ÷ UK£2.4b (Based on trailing 12 months to March 2022).

The “return” is the income that the company has made in the last year. One way to think of this is that the company makes £0.05 profit for every £1 of shareholder capital it has.

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 reinvests, or “retains,” we are then able to assess a company’s future ability to generate profits. In general, companies with a high return on equity and earnings retention, all other things being equal, have a higher growth rate than companies that do not share these characteristics.

Johnson Matthey earnings growth and 4.8% ROE

On the surface, Johnson Matthey’s ROE isn’t much special. A quick further study shows that the company’s ROE also doesn’t compare favorably to the industry average of 14%. For that reason, Johnson Matthey’s 20% net income decline over the past five years isn’t surprising given its lower ROE. We believe there may be other issues negatively impacting the company’s earnings prospects. For example, the company has a very high payout ratio or is under competitive pressure.

That said, we compared Johnson Matthey’s performance to the industry and were concerned to note that while the company has seen earnings shrink, the industry has grown earnings by 3.4% over the same period.

LSE:JMAT Past Earnings Growth Jul 17, 2022

Earnings growth is an important 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 allows them to determine if the future of the stock looks promising or threatening. What is JMAT worth today? The intrinsic value infographic in our free research report helps visualize if JMAT is currently mispriced by the market.

Is Johnson Matthey reinvesting his profits efficiently?

Johnson Matthey’s declining earnings aren’t surprising given that the company spends most of its earnings paying dividends, given its three-year median payout ratio of 63% (or a retention ratio of 37%). With very little left to reinvest in the business, earnings growth is far from likely. You can see the 4 risks we have identified for Johnson Matthey by visiting our Risk Dashboard for free on our platform here.

Additionally, Johnson Matthey has paid dividends for at least a decade, meaning the company’s management is committed to paying dividends even if it means little to no earnings growth. Studying the latest analyst consensus data, we found that the company’s future payout ratio is expected to drop to 40% over the next three years. Accordingly, the expected decline in the payout ratio explains the company’s expected increase in ROE to 14% over the same period.

summary

Overall, Johnson Matthey’s performance is a pretty big disappointment. Given that the company doesn’t reinvest much in the business and given the low ROE, it’s not surprising that earnings aren’t growing, if at all. Against this background, the latest forecasts from industry analysts show that the analysts expect a huge improvement in the company’s earnings growth rate. Are these analyst expectations based on broader expectations for the industry or on company fundamentals? Click here to go to our analyst’s forecast page for the company.

This Simply Wall St article is of a general nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.

About Nina Snider

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