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Do Its Financials Have Any Role To Play In Driving A. O. Smith Corporation's (NYSE:AOS) Stock Up Recently?

A. O. Smith's (NYSE:AOS) stock is up by a considerable 13% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study A. O. Smith's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for A. O. Smith

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

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So, based on the above formula, the ROE for A. O. Smith is:

13% = US$236m ÷ US$1.7b (Based on the trailing twelve months to December 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.13 in profit.

What Is The Relationship Between ROE And 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. 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.

A. O. Smith's Earnings Growth And 13% ROE

To begin with, A. O. Smith seems to have a respectable ROE. Even so, when compared with the average industry ROE of 19%, we aren't very excited. However, the moderate 5.5% net income growth seen by A. O. Smith over the past five years is definitely a positive. So, there might be other aspects that are positively influencing earnings growth. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also provides some context to the earnings growth seen by the company.

As a next step, we compared A. O. Smith's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 14% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about A. O. Smith's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is A. O. Smith Making Efficient Use Of Its Profits?

A. O. Smith has a three-year median payout ratio of 40%, which implies that it retains the remaining 60% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, A. O. Smith 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 35% of its profits over the next three years. Regardless, the future ROE for A. O. Smith is predicted to rise to 28% despite there being not much change expected in its payout ratio.

Conclusion

In total, it does look like A. O. Smith has some positive aspects to its business. In particular, it's great to see that the company is investing heavily into its business and along with a moderate rate of return, that has resulted in a respectable growth in its earnings. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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