It is hard to get excited after looking at Timken's (NYSE:TKR) recent performance, when its stock has declined 22% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Timken'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
We've discovered 2 warning signs about Timken. View them for free.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 Timken is:
13% = US$375m ÷ US$3.0b (Based on the trailing twelve months to December 2024).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.13 in profit.
Check out our latest analysis for Timken
What Has ROE Got To Do With 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. 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 13% ROE
At first glance, Timken seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. Despite the moderate return on equity, Timken has posted a net income growth of 2.8% over the past five years. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, on comparing with the industry net income growth, we found that Timken's reported growth was lower than the industry growth of 16% over the last few years, which is not something we like to see.
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). Doing so will help them establish if the stock's future looks promising or ominous. 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?
A low three-year median payout ratio of 24% (implying that the company retains the remaining 76% of its income) suggests that Timken is retaining most of its profits. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Timken has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 21% of its profits over the next three years. Accordingly, forecasts suggest that Timken's future ROE will be 13% which is again, similar to the current ROE.
Summary
In total, it does look like Timken has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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.