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Otter Tail (NASDAQ:OTTR) has had a great run on the share market with its stock up by a significant 6.1% over the last month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Otter Tail'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.
How Is ROE Calculated?
Return on equity 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 Otter Tail is:
11% = US$98m ÷ US$852m (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.11 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. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Otter Tail's Earnings Growth And 11% ROE
To start with, Otter Tail's ROE looks acceptable. On comparing with the average industry ROE of 9.4% the company's ROE looks pretty remarkable. Probably as a result of this, Otter Tail was able to see a decent growth of 9.7% over the last five years.
As a next step, we compared Otter Tail'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 7.3%.
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). This then helps them determine if the stock is placed for a bright or bleak future. Is Otter Tail fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Otter Tail Efficiently Re-investing Its Profits?
Otter Tail has a significant three-year median payout ratio of 65%, meaning that it is left with only 35% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Moreover, Otter Tail 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 62% of its profits over the next three years. Accordingly, forecasts suggest that Otter Tail's future ROE will be 11% which is again, similar to the current ROE.
On the whole, we feel that Otter Tail's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
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