Declining Stock and Decent Financials: Is The Market Wrong About MSC Industrial Direct Co., Inc. (NYSE:MSM)?
With its stock down 4.6% over the past three months, it is easy to disregard MSC Industrial Direct (NYSE:MSM). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study MSC Industrial Direct'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for MSC Industrial Direct
How Is ROE Calculated?
Return on equity 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 MSC Industrial Direct is:
24% = US$331m ÷ US$1.4b (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.24.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
MSC Industrial Direct's Earnings Growth And 24% ROE
Firstly, we acknowledge that MSC Industrial Direct has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 19% which is quite remarkable. Despite this, MSC Industrial Direct's five year net income growth was quite low averaging at only 4.6%. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
We then compared MSC Industrial Direct's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 24% in the same 5-year period, which is a bit concerning.
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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for MSM? You can find out in our latest intrinsic value infographic research report.
Is MSC Industrial Direct Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 55% (that is, the company retains only 45% of its income) over the past three years for MSC Industrial Direct suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.
Moreover, MSC Industrial Direct has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 49%. As a result, MSC Industrial Direct's ROE is not expected to change by much either, which we inferred from the analyst estimate of 24% for future ROE.
Summary
In total, it does look like MSC Industrial Direct 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. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.
