Reliance Worldwide (ASX:RWC) has had a rough month with its share price down 7.2%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Reliance Worldwide's ROE.

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

Check out our latest analysis for Reliance Worldwide

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 Reliance Worldwide is:

8.7% = US$110m ÷ US$1.3b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.09 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Reliance Worldwide's Earnings Growth And 8.7% ROE

On the face of it, Reliance Worldwide's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.0%. Having said that, Reliance Worldwide has shown a modest net income growth of 10% over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Reliance Worldwide's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 11% in the same 5-year 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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for RWC? You can find out in our latest intrinsic value infographic research report.

Is Reliance Worldwide Using Its Retained Earnings Effectively?

Reliance Worldwide has a significant three-year median payout ratio of 74%, meaning that it is left with only 26% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Reliance Worldwide is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 26% over the next three years. As a result, the expected drop in Reliance Worldwide's payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.

Conclusion

Overall, we feel that Reliance Worldwide certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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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.