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Kennametal's (NYSE:KMT) stock up by 4.1% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Kennametal'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 Kennametal is:
8.6% = US$117m ÷ US$1.4b (Based on the trailing twelve months to September 2021).
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 $0.09 in profit.
What Is The Relationship Between ROE And 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. 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.
Kennametal's Earnings Growth And 8.6% ROE
When you first look at it, Kennametal's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 10%, we may spare it some thought. Having said that, Kennametal has shown a modest net income growth of 10% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving 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.
As a next step, we compared Kennametal'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 8.5%.
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. What is KMT worth today? The intrinsic value infographic in our free research report helps visualize whether KMT is currently mispriced by the market.
Is Kennametal Efficiently Re-investing Its Profits?
With a three-year median payout ratio of 30% (implying that the company retains 70% of its profits), it seems that Kennametal is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Additionally, Kennametal 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 31%. Regardless, the future ROE for Kennametal is predicted to rise to 14% despite there being not much change expected in its payout ratio.
Overall, we feel that Kennametal certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.