Is Weakness In Renishaw plc (LON:RSW) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?
It is hard to get excited after looking at Renishaw's (LON:RSW) recent performance, when its stock has declined 8.4% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. 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 Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Renishaw is:
13% = UK£116m ÷ UK£897m (Based on the trailing twelve months to June 2023).
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.
What Has ROE Got To Do With 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.
Renishaw's Earnings Growth And 13% ROE
To start with, Renishaw's ROE looks acceptable. Especially when compared to the industry average of 9.8% the company's ROE looks pretty impressive. This certainly adds some context to Renishaw's decent 5.5% net income growth seen over the past five years.
We then compared Renishaw's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 7.0% in the same 5-year period, which is a bit concerning.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Using Its Retained Earnings Effectively?
Renishaw has a three-year median payout ratio of 42%, which implies that it retains the remaining 58% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Additionally, Renishaw 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 49%. As a result, Renishaw's ROE is not expected to change by much either, which we inferred from the analyst estimate of 12% for future ROE.
Conclusion
Overall, we are quite pleased with Renishaw's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
