Stanley Black & Decker, Inc.'s (NYSE:SWK) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
Most readers would already be aware that Stanley Black & Decker's (NYSE:SWK) stock increased significantly by 12% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, 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 Stanley Black & Decker's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Stanley Black & Decker
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 Stanley Black & Decker is:
11% = US$1.2b ÷ US$11b (Based on the trailing twelve months to January 2021).
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 $0.11.
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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
A Side By Side comparison of Stanley Black & Decker's Earnings Growth And 11% ROE
To start with, Stanley Black & Decker's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. For this reason, Stanley Black & Decker's five year net income decline of 3.4% raises the question as to why the decent ROE didn't translate into growth. 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 Stanley Black & Decker's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.6% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Stanley Black & Decker fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Stanley Black & Decker Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 44% (where it is retaining 56% of its profits), Stanley Black & Decker has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Stanley Black & Decker 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 26% over the next three years. As a result, the expected drop in Stanley Black & Decker's payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.
Conclusion
On the whole, we do feel that Stanley Black & Decker has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high 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. 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.
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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