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With its stock down 20% over the past three months, it is easy to disregard Timken (NYSE:TKR). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Timken'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To Calculate Return On Equity?
The formula for return on equity is:
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 income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.13 in profit.
View our latest analysis for Timken
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. 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. 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.
Timken's Earnings Growth And 13% ROE
To start with, Timken's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 14%. Despite the modest returns, Timken's five year net income growth was quite low, averaging at only 2.8%. 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.
As a next step, we compared Timken'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 16% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is TKR fairly valued? This infographic on the company's intrinsic value has everything you need to know.