Rotork's (LON:ROR) stock was mostly flat over the past three months. However, attentive investors would probably give more consideration to the stock as the company's fundamentals could add more to the story, given how long-term financials are usually what drive market prices. Particularly, we will be paying attention to Rotork's ROE today.

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.

View our latest analysis for Rotork

How To Calculate Return On Equity?

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 Rotork is:

20% = UK£120m ÷ UK£608m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £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. 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.

A Side By Side comparison of Rotork's Earnings Growth And 20% ROE

To start with, Rotork's ROE looks acceptable. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. Yet, Rotork has posted measly growth of 5.0% over the past five years. 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 poor allocation of capital.

As a next step, we compared Rotork'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 9.3% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is ROR fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Rotork Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 62% (that is, the company retains only 38% of its income) over the past three years for Rotork suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

In addition, Rotork 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 48% 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 do feel that Rotork has some positive attributes. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.