Twin Disc, Incorporated's (NASDAQ:TWIN) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
Twin Disc (NASDAQ:TWIN) has had a great run on the share market with its stock up by a significant 10% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Twin Disc'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Twin Disc
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 Twin Disc is:
7.8% = US$11m ÷ US$140m (Based on the trailing twelve months to September 2023).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.08 in profit.
Why Is ROE Important For 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. 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.
Twin Disc's Earnings Growth And 7.8% ROE
When you first look at it, Twin Disc's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. However, the moderate 6.3% net income growth seen by Twin Disc over the past five years is definitely a positive. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
We then compared Twin Disc's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.8% in the same 5-year period, which is a bit concerning.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 Twin Disc is trading on a high P/E or a low P/E, relative to its industry.
Is Twin Disc Using Its Retained Earnings Effectively?
Twin Disc's three-year median payout ratio to shareholders is 5.1% (implying that it retains 95% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Additionally, Twin Disc has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.
Summary
On the whole, we do feel that Twin Disc has some positive attributes. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors.
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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.
