U.S. markets closed
  • S&P 500

    4,411.79
    +44.31 (+1.01%)
     
  • Dow 30

    35,061.55
    +238.20 (+0.68%)
     
  • Nasdaq

    14,836.99
    +152.39 (+1.04%)
     
  • Russell 2000

    2,209.65
    +10.17 (+0.46%)
     
  • Crude Oil

    72.04
    +0.13 (+0.18%)
     
  • Gold

    1,802.10
    -3.30 (-0.18%)
     
  • Silver

    25.26
    -0.12 (-0.48%)
     
  • EUR/USD

    1.1779
    +0.0006 (+0.05%)
     
  • 10-Yr Bond

    1.2860
    +0.0210 (+1.66%)
     
  • GBP/USD

    1.3751
    -0.0016 (-0.12%)
     
  • USD/JPY

    110.5220
    +0.4070 (+0.37%)
     
  • BTC-USD

    32,444.85
    +147.38 (+0.46%)
     
  • CMC Crypto 200

    783.92
    -9.81 (-1.24%)
     
  • FTSE 100

    7,027.58
    +59.28 (+0.85%)
     
  • Nikkei 225

    27,548.00
    +159.80 (+0.58%)
     

Is Renishaw plc's (LON:RSW) Stock Price Struggling As A Result Of Its Mixed Financials?

  • Oops!
    Something went wrong.
    Please try again later.
  • Oops!
    Something went wrong.
    Please try again later.
·4 min read
In this article:
  • Oops!
    Something went wrong.
    Please try again later.
  • Oops!
    Something went wrong.
    Please try again later.

Renishaw (LON:RSW) has had a rough three months with its share price down 2.2%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Renishaw's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Renishaw

How Do You Calculate Return On Equity?

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 Renishaw is:

7.3% = UK£45m ÷ UK£625m (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.07 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. 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.

Renishaw's Earnings Growth And 7.3% ROE

At first glance, Renishaw's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 8.8%, we may spare it some thought. But then again, Renishaw's five year net income shrunk at a rate of 12%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared Renishaw's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.2% 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. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Renishaw is trading on a high P/E or a low P/E, relative to its industry.

Is Renishaw Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 34% (that is, a retention ratio of 66%), the fact that Renishaw's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Renishaw 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 is expected to keep paying out approximately 36% of its profits over the next three years. However, Renishaw's ROE is predicted to rise to 17% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we have mixed feelings about Renishaw. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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.

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.

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