Donaldson Company's (NYSE:DCI) stock up by 2.3% over the past month. Since the market usually pay for a company's long-term financial health, we decided to study the company's fundamentals to see if they could be influencing the market. Specifically, we decided to study Donaldson Company'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Donaldson Company
How Is ROE Calculated?
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 Donaldson Company is:
27% = US$364m ÷ US$1.3b (Based on the trailing twelve months to October 2023).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.27 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
A Side By Side comparison of Donaldson Company's Earnings Growth And 27% ROE
To begin with, Donaldson Company has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 15% the company's ROE is quite impressive. This probably laid the groundwork for Donaldson Company's moderate 8.2% net income growth seen over the past five years.
As a next step, we compared Donaldson Company'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 8.8% in the same period.
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. Has the market priced in the future outlook for DCI? You can find out in our latest intrinsic value infographic research report.
Is Donaldson Company Using Its Retained Earnings Effectively?
Donaldson Company has a three-year median payout ratio of 35%, which implies that it retains the remaining 65% 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, Donaldson Company 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's future payout ratio is expected to drop to 25% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
Summary
On the whole, we feel that Donaldson Company's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.