Is A. O. Smith Corporation's (NYSE:AOS) Recent Stock Performance Influenced By Its Financials In Any Way?
Most readers would already know that A. O. Smith's (NYSE:AOS) stock increased by 3.3% 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. Particularly, we will be paying attention to A. O. Smith'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.
Check out our latest analysis for A. O. Smith
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 A. O. Smith is:
14% = US$274m ÷ US$1.9b (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.14.
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. O. Smith's Earnings Growth And 14% ROE
To begin with, A. O. Smith seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 20% does temper our expectations. Further, A. O. Smith's five year net income growth of -0.5% is more or less flat. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So there might be other reasons for the flat earnings growth. These include low earnings retention or poor capital allocation.
As a next step, we compared A. O. Smith's net income growth with the industry and discovered that the industry saw an average growth of 12% 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. If you're wondering about A. O. Smith's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is A. O. Smith Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 41% (meaning the company retains59% of profits) in the last three-year period, A. O. Smith's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, A. O. Smith has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings 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 27%, over the same period.
Conclusion
In total, it does look like A. O. Smith has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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.
