Yahoo Finance Is Xylem Inc.'s (NYSE:XYL) Stock Price Struggling As A Result Of Its Mixed Financials?
With its stock down 7.2% over the past three months, it is easy to disregard Xylem (NYSE:XYL). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Xylem's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Xylem
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 Xylem is:
10% = US$355m ÷ US$3.5b (Based on the trailing twelve months to December 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 $0.10 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Xylem's Earnings Growth And 10% ROE
At first glance, Xylem seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 13% does temper our expectations. Moreover, Xylem's net income shrunk at a rate of 3.2%over the past five years. Not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. Hence there might be some other aspects that are causing earnings to shrink. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
However, when we compared Xylem's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.5% in the same period. This is quite worrisome.
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. If you're wondering about Xylem's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Xylem Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 51% (implying that 49% of the profits are retained), most of Xylem's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.
In addition, Xylem has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 36% over the next three years. The fact that the company's ROE is expected to rise to 17% over the same period is explained by the drop in the payout ratio.
Conclusion
In total, we're a bit ambivalent about Xylem's performance. Specifically, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return. Investors may have benefitted, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.
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