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Watsco, Inc.'s (NYSE:WSO) Stock Is Going Strong: Is the Market Following Fundamentals?

Watsco's (NYSE:WSO) stock is up by a considerable 28% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Watsco's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Watsco

How Do You Calculate Return On Equity?

The formula for return on equity is:

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Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Watsco is:

21% = US$608m ÷ US$2.9b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. On comparing with the average industry ROE of 17% the company's ROE looks pretty remarkable. This probably laid the ground for Watsco's significant 22% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between Watsco's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 25% in the same 5-year period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Watsco fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Watsco Making Efficient Use Of Its Profits?

Watsco has a significant three-year median payout ratio of 63%, meaning the company only retains 37% of its income. This implies that the company has been able to achieve high 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 73%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 21%.

Conclusion

Overall, we are quite pleased with Watsco's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.