Rexnord (NYSE:RXN) has had a great run on the share market with its stock up by a significant 19% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Rexnord’s ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
How To Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Rexnord is:
10% = US$147m ÷ US$1.4b (Based on the trailing twelve months to December 2020).
The ‘return’ is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.10 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.
A Side By Side comparison of Rexnord’s Earnings Growth And 10% ROE
To start with, Rexnord’s ROE looks acceptable. Even when compared to the industry average of 11% the company’s ROE looks quite decent. This certainly adds some context to Rexnord’s moderate 18% net income growth seen over the past five years.
We then compared Rexnord’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 7.6% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. Has the market priced in the future outlook for RXN? You can find out in our latest intrinsic value infographic research report.
Is Rexnord Making Efficient Use Of Its Profits?
Rexnord has a low three-year median payout ratio of 15%, meaning that the company retains the remaining 85% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
While Rexnord has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. 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 17%. Still, forecasts suggest that Rexnord’s future ROE will rise to 16% even though the the company’s payout ratio is not expected to change by much.
In total, we are pretty happy with Rexnord’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. 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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