WD-40 (NASDAQ:WDFC) has had a great run on the share market with its stock up by a significant 14% 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 WD-40's ROE today.
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.
How To 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 WD-40 is:
36% = US$53m ÷ US$148m (Based on the trailing twelve months to February 2020).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.36.
What Has ROE Got To Do With Earnings Growth?
So far, we've learnt that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
WD-40's Earnings Growth And 36% ROE
First thing first, we like that WD-40 has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. This likely paved the way for the modest 6.7% net income growth seen by WD-40 over the past five years. growth
As a next step, we compared WD-40's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 7.0% in the same period.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 WD-40 is trading on a high P/E or a low P/E, relative to its industry.
Is WD-40 Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 51% (or a retention ratio of 49%) for WD-40 suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Besides, WD-40 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 WD-40's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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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