Are Taylor Wimpey plc's (LON:TW.) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?
With its stock down 14% over the past three months, it is easy to disregard Taylor Wimpey (LON:TW.). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Taylor Wimpey's ROE today.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Taylor Wimpey
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Taylor Wimpey is:
13% = UK£556m ÷ UK£4.3b (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.13 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Taylor Wimpey's Earnings Growth And 13% ROE
To start with, Taylor Wimpey's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 11%. As you might expect, the 7.0% net income decline reported by Taylor Wimpey is a bit of a surprise. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
With the industry earnings declining at a rate of 8.2% in the same period, we deduce that both the company and the industry are shrinking at the same rate.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for TW.? You can find out in our latest intrinsic value infographic research report.
Is Taylor Wimpey Making Efficient Use Of Its Profits?
Looking at its three-year median payout ratio of 35% (or a retention ratio of 65%) which is pretty normal, Taylor Wimpey's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, Taylor Wimpey 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 53% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.
Summary
Overall, we feel that Taylor Wimpey 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 and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing 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.
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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.
