Worley's (ASX:WOR) stock is up by a considerable 16% over the past three months. 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. Particularly, we will be paying attention to Worley's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Worley is:
3.2% = AU$188m ÷ AU$5.9b (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.03.
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 chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
A Side By Side comparison of Worley's Earnings Growth And 3.2% ROE
It is quite clear that Worley's ROE is rather low. Even when compared to the industry average of 6.6%, the ROE figure is pretty disappointing. In spite of this, Worley was able to grow its net income considerably, at a rate of 66% in the last five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
We then compared Worley's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 36% in the same period.
Earnings growth is a huge 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is WOR worth today? The intrinsic value infographic in our free research report helps visualize whether WOR is currently mispriced by the market.
Is Worley Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 84% (implying that it keeps only 16% of profits) for Worley suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Moreover, Worley is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 64% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 7.0%, over the same period.
Overall, we feel that Worley certainly does have some positive factors to consider. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. 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.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.