Most readers would already know that Watsco’s (NYSE:WSO) stock increased by 5.3% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company’s key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Watsco’s ROE.
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 Do You 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 Watsco is:
21% = US$636m ÷ US$3.1b (Based on the trailing twelve months to December 2024).
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 $0.21 in profit.
View our latest analysis for Watsco
What Is The Relationship Between ROE And Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Watsco’s Earnings Growth And 21% ROE
To begin with, Watsco seems to have a respectable ROE. Especially when compared to the industry average of 17% the company’s ROE looks pretty impressive. This certainly adds some context to Watsco’s decent 18% net income growth seen over the past five years.
As a next step, we compared Watsco’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 23% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Watsco fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Watsco Efficiently Re-investing Its Profits?
Watsco has a significant three-year median payout ratio of 63%, meaning that it is left with only 37% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Besides, Watsco has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company’s future payout ratio is expected to rise to 82% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.
Conclusion
Overall, we feel that Watsco certainly does have some positive factors to consider. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. With that said, the latest industry analyst forecasts reveal that the company’s earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
Valuation is complex, but we’re here to simplify it.
Discover if Watsco might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
