Donaldson Company, Inc.'s (NYSE:DCI) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?
Donaldson Company (NYSE:DCI) has had a rough three months with its share price down 3.4%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Donaldson Company's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Donaldson Company
How To Calculate Return On Equity?
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 Donaldson Company is:
28% = US$368m ÷ US$1.3b (Based on the trailing twelve months to April 2023).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.28 in profit.
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. 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.
A Side By Side comparison of Donaldson Company's Earnings Growth And 28% ROE
To begin with, Donaldson Company has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 13% also doesn't go unnoticed by us. This probably laid the groundwork for Donaldson Company's moderate 11% net income growth seen over the past five years.
As a next step, we compared Donaldson Company's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.7%.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is DCI fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Donaldson Company Efficiently Re-investing Its Profits?
Donaldson Company has a healthy combination of a moderate three-year median payout ratio of 36% (or a retention ratio of 64%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Additionally, Donaldson Company has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 27% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
Conclusion
In total, we are pretty happy with Donaldson Company'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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
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