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Kennametal (NYSE:KMT) has had a rough three months with its share price down 9.5%. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Particularly, we will be paying attention to Kennametal'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.
Check out our latest analysis for Kennametal
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Kennametal is:
9.8% = US$128m ÷ US$1.3b (Based on the trailing twelve months to March 2023).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.10.
Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Kennametal's Earnings Growth And 9.8% ROE
When you first look at it, Kennametal's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 13% either. For this reason, Kennametal's five year net income decline of 17% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared Kennametal's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.3% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is KMT worth today? The intrinsic value infographic in our free research report helps visualize whether KMT is currently mispriced by the market.