Most readers would already be aware that BorgWarner’s (NYSE:BWA) stock increased significantly by 8.8% over the past month. We wonder if and what role the company’s financials play in that price change as a company’s long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on BorgWarner’s ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for BorgWarner
How Do You 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 BorgWarner is:
13% = US$832m ÷ US$6.3b (Based on the trailing twelve months to June 2024).
The ‘return’ is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.13 in profit.
What Has ROE Got To Do With 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.
BorgWarner’s Earnings Growth And 13% ROE
To begin with, BorgWarner seems to have a respectable ROE. Even when compared to the industry average of 12% the company’s ROE looks quite decent. Despite the modest returns, BorgWarner’s five year net income growth was quite low, averaging at only 2.8%. A few likely reasons that could be keeping earnings growth low are – the company has a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that BorgWarner’s reported growth was lower than the industry growth of 16% over the last few years, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. 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. If you’re wondering about BorgWarner’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is BorgWarner Using Its Retained Earnings Effectively?
A low three-year median payout ratio of 21% (implying that the company retains the remaining 79% of its income) suggests that BorgWarner is retaining most of its profits. This should be reflected in its earnings growth number, but that’s not the case. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Moreover, BorgWarner has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company’s future payout ratio is expected to drop to 10% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Conclusion
In total, it does look like BorgWarner has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn’t the case here. This suggests that there might be some external threat to the business, that’s hampering its growth. With that said, the latest industry analyst forecasts reveal that the company’s earnings are expected to accelerate. 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.