With its stock down 12% over the past three months, it is easy to disregard Watts Water Technologies (NYSE:WTS). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Watts Water Technologies' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Watts Water Technologies is:
15% = US$179m ÷ US$1.2b (Based on the trailing twelve months to March 2022).
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 $0.15 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. 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 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.
Watts Water Technologies' Earnings Growth And 15% ROE
At first glance, Watts Water Technologies seems to have a decent ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. This certainly adds some context to Watts Water Technologies' decent 13% net income growth seen over the past five years.
As a next step, we compared Watts Water Technologies' 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 8.8%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for WTS? You can find out in our latest intrinsic value infographic research report.
Is Watts Water Technologies Using Its Retained Earnings Effectively?
In Watts Water Technologies' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 23% (or a retention ratio of 77%), which suggests that the company is investing most of its profits to grow its business.
Additionally, Watts Water Technologies has paid dividends over a period of at least ten 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 17% over the next three years.
Overall, we are quite pleased with Watts Water Technologies' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.