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Is MSC Industrial Direct Co., Inc.'s (NYSE:MSM) Recent Stock Performance Influenced By Its Financials In Any Way?

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MSC Industrial Direct's (NYSE:MSM) stock is up by 6.3% 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. In this article, we decided to focus on MSC Industrial Direct's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for MSC Industrial Direct

How To 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 MSC Industrial Direct is:

24% = US$297m ÷ US$1.2b (Based on the trailing twelve months to February 2022).

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 $0.24 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. 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.

MSC Industrial Direct's Earnings Growth And 24% ROE

First thing first, we like that MSC Industrial Direct has an impressive ROE. Further, even comparing with the industry average if 23%, the company's ROE is quite respectable. Needless to say, we are quite surprised to see that MSC Industrial Direct's net income shrunk at a rate of 2.7% over the past five years in spite of its decent. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared MSC Industrial Direct's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 16% in the same period. This is quite worrisome.

past-earnings-growth
past-earnings-growth

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. Has the market priced in the future outlook for MSM? You can find out in our latest intrinsic value infographic research report.

Is MSC Industrial Direct Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 63% (implying that 37% of the profits are retained), most of MSC Industrial Direct's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 3 risks we have identified for MSC Industrial Direct.

Moreover, MSC Industrial Direct 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 52% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 24%.

Summary

Overall, we feel that MSC Industrial Direct certainly does have some positive factors to consider. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.