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It is hard to get excited after looking at Watsco's (NYSE:WSO) recent performance, when its stock has declined 3.9% over the past week. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Watsco'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.
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 Watsco is:
21% = US$636m ÷ US$3.1b (Based on the trailing twelve months to December 2024).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.21 in profit.
See our latest analysis for Watsco
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
Watsco's Earnings Growth And 21% ROE
To start with, Watsco's ROE looks acceptable. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. This probably laid the ground for Watsco's moderate 18% net income growth seen over the past five years.
We then compared Watsco's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 23% in the same 5-year period, which is a bit concerning.
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. 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.