Encore Wire (NASDAQ:WIRE) has had a great run on the share market with its stock up by a significant 31% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Encore Wire’s ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
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 Encore Wire is:
25% = US$269m ÷ US$1.1b (Based on the trailing twelve months to June 2021).
The ‘return’ is the yearly profit. So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.25.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. 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 Encore Wire’s Earnings Growth And 25% ROE
To begin with, Encore Wire has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 13% the company’s ROE is quite impressive. So, the substantial 25% net income growth seen by Encore Wire over the past five years isn’t overly surprising.
As a next step, we compared Encore Wire’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 7.1%.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Encore Wire is trading on a high P/E or a low P/E, relative to its industry.
Is Encore Wire Efficiently Re-investing Its Profits?
Encore Wire’s three-year median payout ratio to shareholders is 2.2%, which is quite low. This implies that the company is retaining 98% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Besides, Encore Wire has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.
On the whole, we feel that Encore Wire’s performance has been quite good. 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 sizeable growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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. 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.
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