Kennametal (NYSE:KMT) has had a rough month with its share price down 6.0%.   Given that stock prices are usually driven by a company's fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators.     Specifically, we decided to study Kennametal's  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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

ROE 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 Kennametal is:

9.4% = US$126m ÷ US$1.3b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year.  One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.09 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.  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 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.

Kennametal's Earnings Growth And 9.4% ROE

At first glance, Kennametal's ROE doesn't look very promising.   We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%.   Therefore, it might not be wrong to say that the five year net income decline of 8.3% seen by Kennametal was probably the result of it having a lower ROE.  We believe that there also might be other aspects that are negatively influencing the company's earnings prospects.  For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.    

So, as a next step, we compared Kennametal's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.4% over the last few years.  

NYSE:KMT Past Earnings Growth April 13th 2024

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.    What is KMT worth today? The  intrinsic value infographic in our free research report  helps visualize whether KMT is currently mispriced by the market.  

Is Kennametal Making Efficient Use Of Its Profits?  

Kennametal has a high three-year median payout ratio of 53% (that is, it is retaining 47% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking.    With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.      

In addition, Kennametal 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 is expected to keep paying out approximately 46% of its profits over the next three years.   Accordingly, forecasts suggest that Kennametal's future ROE will be 11% which is again, similar to the current ROE.    

Conclusion  

On the whole, Kennametal's performance is quite a big let-down.      As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate.       That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate.     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.

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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.