Do Its Financials Have Any Role To Play In Driving Johnson Matthey Plc's (LON:JMAT) Stock Up Recently?
Most readers would already be aware that Johnson Matthey's (LON:JMAT) stock increased significantly by 16% over the past week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Johnson Matthey's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Johnson Matthey
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 Johnson Matthey is:
10% = UK£264m ÷ UK£2.5b (Based on the trailing twelve months to March 2023).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.10 in profit.
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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
A Side By Side comparison of Johnson Matthey's Earnings Growth And 10% ROE
To begin with, Johnson Matthey seems to have a respectable ROE. Even when compared to the industry average of 9.1% the company's ROE looks quite decent. As you might expect, the 13% net income decline reported by Johnson Matthey is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
So, as a next step, we compared Johnson Matthey's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 2.4% over the last few years.
The basis for attaching value to a company is, to a great extent, 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for JMAT? You can find out in our latest intrinsic value infographic research report.
Is Johnson Matthey Using Its Retained Earnings Effectively?
Johnson Matthey has a high three-year median payout ratio of 71% (that is, it is retaining 29% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.
Moreover, Johnson Matthey 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 40% over the next three years. The fact that the company's ROE is expected to rise to 13% over the same period is explained by the drop in the payout ratio.
Conclusion
On the whole, we do feel that Johnson Matthey has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
