It is hard to get excited after looking at Snap-on's (NYSE:SNA) recent performance, when its stock has declined 5.6% over the past week. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Snap-on's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Snap-on is:
20% = US$826m ÷ US$4.1b (Based on the trailing twelve months to October 2021).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.20 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. 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.
A Side By Side comparison of Snap-on's Earnings Growth And 20% ROE
To begin with, Snap-on seems to have a respectable ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This probably laid the ground for Snap-on's moderate 5.9% net income growth seen over the past five years.
We then compared Snap-on's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.2% in the same period, which is a bit concerning.NYSE:SNA Past Earnings Growth October 26th 2021
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is SNA fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Snap-on Making Efficient Use Of Its Profits?
Snap-on has a three-year median payout ratio of 33%, which implies that it retains the remaining 67% 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.
Moreover, Snap-on is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 32% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 20%.
In total, we are pretty happy with Snap-on's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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