Is Weakness In Reliance Worldwide Corporation Limited (ASX:RWC) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?
It is hard to get excited after looking at Reliance Worldwide's (ASX:RWC) recent performance, when its stock has declined 32% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Reliance Worldwide's ROE in this article.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Reliance Worldwide
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 Reliance Worldwide is:
11% = US$135m ÷ US$1.2b (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.11 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.
A Side By Side comparison of Reliance Worldwide's Earnings Growth And 11% ROE
To begin with, Reliance Worldwide seems to have a respectable ROE. Even when compared to the industry average of 9.8% the company's ROE looks quite decent. This certainly adds some context to Reliance Worldwide's exceptional 27% net income growth seen over the past five years. However, there could also be other drivers 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.
We then compared Reliance Worldwide's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 7.7% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is RWC worth today? The intrinsic value infographic in our free research report helps visualize whether RWC is currently mispriced by the market.
Is Reliance Worldwide Making Efficient Use Of Its Profits?
Reliance Worldwide's significant three-year median payout ratio of 77% (where it is retaining only 23% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.
Additionally, Reliance Worldwide has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 49% over the next three years. The fact that the company's ROE is expected to rise to 14% over the same period is explained by the drop in the payout ratio.
Conclusion
On the whole, we feel that Reliance Worldwide's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
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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.
