Flowserve Corporation's (NYSE:FLS) Dismal Stock Performance Reflects Weak Fundamentals
It is hard to get excited after looking at Flowserve's (NYSE:FLS) recent performance, when its stock has declined 4.2% over the past week. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on Flowserve'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Flowserve
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Flowserve is:
7.4% = US$130m ÷ US$1.7b (Based on the trailing twelve months to March 2021).
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 $0.07 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 Flowserve's Earnings Growth And 7.4% ROE
At first glance, Flowserve's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 11% either. As a result, Flowserve's flat net income growth over the past five years doesn't come as a surprise given its lower ROE.
Next, on comparing with the industry net income growth, we found that Flowserve's reported growth was lower than the industry growth of 8.1% in the same period, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is FLS fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Flowserve Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 52% (meaning, the company retains only 48% of profits) for Flowserve suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.
In addition, Flowserve has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 29% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 15%, over the same period.
Conclusion
In total, we would have a hard think before deciding on any investment action concerning Flowserve. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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.
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