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As most readers should already be aware, Renishaw (LON:RSW) stock is up a substantial 6.7% over the past week. Because stock prices are typically aligned with a company’s financial performance over the long term, we decided to take a closer look at its financial indicators to see if they played a role in the recent price movement. Today we will be paying special attention to Renishaw’s ROE.
Return on Equity or ROE is an important factor to consider by a shareholder as it tells them how effectively their capital is being reinvested. Put simply, it is used to assess a company’s profitability in relation to its equity.
Check out our latest analysis for Renishaw
How do you calculate return on equity?
That Formula for ROE is:
Return on Equity = Net Income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for Renishaw is:
17% = UK£128m ÷ UK£730m (Based on trailing 12 months to December 2021).
“Yield” refers to a company’s profits over the last year. One way to conceptualize this is that the company makes a profit of £0.17 for every £1 in shareholder capital it has.
Why is ROE important for earnings growth?
So far we’ve learned that ROE measures how efficiently a company generates its profits. 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. Assuming all else remains the same, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.
A head-to-head comparison of Renishaw’s earnings growth and 17% ROE
First of all, Renishaw’s ROE looks acceptable. Especially when compared to the industry average of 12%, the company’s ROE looks pretty impressive. For this reason, the five-year decline in Renishaw’s net income of 7.9% raises the question of why the high ROE has not translated into earnings growth. Based on this, we believe that there might be other reasons not discussed so far in this article that might hamper the growth of the company. These include poor earnings retention or poor capital allocation.
Additionally, we found that Renishaw’s performance is quite disappointing even when compared to the industry, which has shrunk 0.5% over the same period, as this suggests the company has shrunk its earnings faster than the industry.
Much of the basis for increasing the value of a company is tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). That way they have an idea if the stock is headed into clear blue waters or if swampy waters await them. If you’re wondering about Renishaw’s valuation, check out this price-to-earnings benchmark against its industry.
Is Renishaw using its profits efficiently?
Despite a normal three-year median payout ratio of 40% (with 60% of earnings being retained), Renishaw has seen its earnings fall, as we saw above. So there could be other explanations in this regard. For example, the company’s business may deteriorate.
Additionally, Renishaw has been paying dividends for at least a decade, suggesting management must have recognized that shareholders prefer dividends to earnings growth. Our latest analyst data shows that the company’s future payout ratio is expected to be around 44% over the next three years. Therefore, the company’s future ROE is not expected to change much either, as analysts are predicting an ROE of 17%.
summary
Overall, it looks like Renishaw has some positives in its business. However, given the high ROE and high earnings retention, we would expect the company to deliver strong earnings growth, but that’s not the case here. This suggests that there could be an external threat to the company that is hampering its growth. Against this background, the latest forecasts from industry analysts indicate that the analysts expect a huge improvement in the company’s earnings growth rate. To learn more about the company’s future earnings growth projections, take a look free Report on analyst forecasts for the company to learn more.
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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.
