Yahoo Finance Are A. O. Smith Corporation's (NYSE:AOS) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?
It is hard to get excited after looking at A. O. Smith's (NYSE:AOS) recent performance, when its stock has declined 4.3% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to A. O. Smith's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for A. O. Smith
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 A. O. Smith is:
31% = US$577m ÷ US$1.9b (Based on the trailing twelve months to March 2024).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.31 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
A. O. Smith's Earnings Growth And 31% ROE
Firstly, we acknowledge that A. O. Smith has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 19% also doesn't go unnoticed by us. Despite this, A. O. Smith's five year net income growth was quite low averaging at only 2.3%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.
As a next step, we compared A. O. Smith'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 14% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is AOS fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is A. O. Smith Using Its Retained Earnings Effectively?
While A. O. Smith has a decent three-year median payout ratio of 36% (or a retention ratio of 64%), it has seen very little growth in earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, A. O. Smith 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 29%. Accordingly, forecasts suggest that A. O. Smith's future ROE will be 30% which is again, similar to the current ROE.
Conclusion
Overall, we feel that A. O. Smith certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
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