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Reliance Steel & Aluminum (NYSE:RS) has had a great run on the share market with its stock up by a significant 5.8% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Reliance Steel & Aluminum'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
ROE 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 Steel & Aluminum is:
15% = US$827m ÷ US$5.6b (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.15.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Reliance Steel & Aluminum's Earnings Growth And 15% ROE
At first glance, Reliance Steel & Aluminum seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 17%. Consequently, this likely laid the ground for the decent growth of 9.7% seen over the past five years by Reliance Steel & Aluminum.
Next, on comparing with the industry net income growth, we found that Reliance Steel & Aluminum's reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 RS? You can find out in our latest intrinsic value infographic research report.
Is Reliance Steel & Aluminum Using Its Retained Earnings Effectively?
Reliance Steel & Aluminum's three-year median payout ratio to shareholders is 23% (implying that it retains 77% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Moreover, Reliance Steel & Aluminum 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 25%. As a result, Reliance Steel & Aluminum's ROE is not expected to change by much either, which we inferred from the analyst estimate of 12% for future ROE.
Overall, we are quite pleased with Reliance Steel & Aluminum's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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