Is Weakness In The Timken Company (NYSE:TKR) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?
Timken (NYSE:TKR) has had a rough three months with its share price down 6.4%. 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. Particularly, we will be paying attention to Timken'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 Timken
How Is ROE Calculated?
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 Timken is:
14% = US$324m ÷ US$2.3b (Based on the trailing twelve months to March 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 $0.14.
Why Is ROE Important For 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. 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.
Timken's Earnings Growth And 14% ROE
To start with, Timken's ROE looks acceptable. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This probably laid the ground for Timken's significant 21% net income growth seen over the past five years. However, there could also be other causes behind this growth. 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.
As a next step, we compared Timken's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.0%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is TKR worth today? The intrinsic value infographic in our free research report helps visualize whether TKR is currently mispriced by the market.
Is Timken Efficiently Re-investing Its Profits?
Timken's three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Timken is reinvesting its earnings efficiently.
Additionally, Timken 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 18% over the next three years. The fact that the company's ROE is expected to rise to 18% over the same period is explained by the drop in the payout ratio.
Summary
In total, we are pretty happy with Timken's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to 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.
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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