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Westinghouse Air Brake Technologies (NYSE:WAB) has had a rough week with its share price down 3.2%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Westinghouse Air Brake Technologies' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Westinghouse Air Brake Technologies is:
4.1% = US$412m ÷ US$10b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.04 in profit.
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.
Westinghouse Air Brake Technologies' Earnings Growth And 4.1% ROE
When you first look at it, Westinghouse Air Brake Technologies' ROE doesn't look that attractive. Next, when compared to the average industry ROE of 11%, the company's ROE leaves us feeling even less enthusiastic. Therefore, Westinghouse Air Brake Technologies' flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
Next, on comparing with the industry net income growth, we found that Westinghouse Air Brake Technologies' reported growth was lower than the industry growth of 7.6% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 WAB? You can find out in our latest intrinsic value infographic research report.
Is Westinghouse Air Brake Technologies Making Efficient Use Of Its Profits?
Westinghouse Air Brake Technologies' low three-year median payout ratio of 20%, (meaning the company retains80% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.
Moreover, Westinghouse Air Brake Technologies has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 10% over the next three years. The fact that the company's ROE is expected to rise to 9.3% over the same period is explained by the drop in the payout ratio.
On the whole, we feel that the performance shown by Westinghouse Air Brake Technologies can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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